Economics, according to a widely accepted definition, is the study of the allocation of scarce re-sources among unlimited and competing uses. It is the social science that deals with the ways in which men and societies seek to satisfy their material needs and desires, since the means at their disposal do not permit them to do so completely.

Much of the work of the discipline can be fitted into this framework, and no other comes so close to accommodating all of it. However, the framework has a serious shortcoming: it does not encompass the problem of depression, or the inadequacy of aggregate demand. Most modern market economies experience periods in which large quantities of resources are idle—particularly labor and plant capacity—so that the principal question is not in what way to use them, but how to put them to any use at all. The distinction between the problems of allocating resources among uses and of achieving their full use corresponds very roughly to the distinction between the two main branches of economics: microeconomics and macroeconomics. The latter, however, includes some aspects of money and the general level of prices that also have important implications for resource allocation.

Decisions about resource allocation are made in their simplest form within the household, in the familiar process of “making ends meet,” or budgeting; the original meaning of economics was the practice of economy at the household level. What is now called economics was at first called political economy, to draw attention to its broader theater of action.

The concept of scarcity is crucial to an under-standing of resource allocation. Almost all resources are scarce under most circumstances, in the sense that if they were available without cost, more would be used than could be supplied. Even air, the classic example of a limitless resource, can become scarce. Pure air is now the exception in crowded urban areas and air pollution can be prevented only at substantial costs. Water is free in many places but scarce and costly in and or densely populated areas [seeWater resources]. Goods, such as sand or dirt, that may be free in their original location have costs when they are transported to the places at which they are needed.

The counterpart of pervasive scarcity is the unlimited extent of material wants. The overwhelming majority of the world’s population would always like a little more (often a lot more) income and consumption than it has, almost regardless of the current level. The exceptions to this generalization are of two kinds—ascetics (a rare breed in modern societies) and the minute fraction of the world’s population so wealthy that it need never, so to speak, consult the price column of the restaurant menu. Even among the very wealthy, with no desire to increase their consumption, there are some who seek to increase their incomes as a game or as a means of augmenting their power.

Economics as a social science does not examine what people ought to want, as distinguished from what they do want. The first question lies largely in the realm of ethics, aesthetics, or religion. Nevertheless, much writing by professional economists makes assumptions, explicit or implicit, about the proper goals of economic activity. Such writing can be considered economic philosophy rather than economic science narrowly defined. The former is often called normative economics and the latter positive economics. It is a positive statement to say that, other things being equal, a fall in the price of milk will increase its consumption—and the validity of such a statement can be tested against evidence. It is a normative statement to say that therefore the price of milk should be lowered. The second statement is not subject to disproof by evidence and implies that the speaker has personal or social values according to which the consumption of milk is “better” or more important than competing alternatives. If such values are widely shared, they may form an appropriate basis for social policy, but the validity of the values themselves nevertheless remains beyond the reach of scientific confirmation or testing.

The goals of economic activity are often subsumed under the heading “utility,” a construct embracing all of the satisfactions to be obtained through consumption, production, and related behavior [seeUtility]. It is generally assumed that the objective of economic activities is to maximize utility, subject to the limitations of resources, and that utility will be increased by the increased consumption of goods and services. In principle, utility can also be increased by such intangible factors as beautiful scenery, pleasant working conditions, amiable companions, or political power. However, such desiderata are seldom explicitly introduced into economic analysis, for a variety of reasons—some are not subject to measurement, some cannot be produced through economic activity—and when they are specified in detail almost all are very differently evaluated by different people. Moreover, some lie in the domains of other social science disciplines whose methods are better suited to analyze them. The assumption that the principal goal of economic activity is to produce goods and services, while clearly an oversimplification, is nevertheless useful in a wide variety of problems and can be modified in special cases, as seems appropriate.

In a dictatorship the utility to be maximized is that of the dictator; in a slave society it is that of the slave owners rather than the slaves. In free societies it is usually assumed that each person seeks to maximize his own utility and in general will be the best judge of how to do so.

An improved method of raising beef increases utility for beef-eating Americans or Argentines, although not for vegetarians; however, the explanation of such cultural, religious, or taste differences in assessing the value of additional output is not the economist’s task. The national output includes bread and circuses, cathedrals and billboards, vitamins and poisons. The economist can study the forces affecting the market price or cost of each and under some circumstances can also say that a market price does not correctly reflect the underlying values of consumers and producers. Like any other citizen, he has personal opinions based on values that transcend market values, but if he cloaks these with the authority of his discipline, he arrogates wisdom.

The economic value of a particular good will not ordinarily depend on the use to which it is put— the price of a stick of dynamite is the same whether it is used to mine coal or to blow up a bridge.

Almost all societies would judge the value of the outcome to be positive in the first case and negative in the second, but the standards by which this judgment is made are not provided by economists in their scientific capacities.

The purpose of science is to achieve understanding either for its own sake—the satisfaction of “idle” curiosity—or as a basis for prediction and control. Although both elements are present in economics, the latter is particularly evident. [SeePrediction and forecasting, economic.] The predictions sought generally refer to the aggregate behavior of sizable groups of people and not to the behavior of individuals. In most economic inquiries it is sufficient to reach such conclusions as that in a given market the consumption of milk increases 1 per cent in response to a 2 per cent reduction in its price; the economist ordinarily does not care whether this occurs because each family increases its consumption 1 per cent or because half the families increase their consumption 2 per cent and the other half not at all. (This indifference will disappear if the division of families into two groups is nonrandom; for example, it might be valuable to know that low-income families increase their consumption more than high-income families.) An economist almost never attempts to predict the consumption behavior of a particular individual in response to a price change. In some economic studies, data are used in which the observations refer to individuals; such studies as yet typically fail to explain a major part of the variance in individual behavior.

The focus on aggregates makes it possible to summarize the accumulation of economic knowledge in statements of observed regularities, or “laws,” that do not apply to individuals considered singly. The preceding example about milk is a special case of the “law of demand”—the quantities of a commodity or service purchased move inversely with its price, other things being equal. This law is not contradicted by the discovery that some consumers stop buying a commodity whose price falls, because it no longer confers social distinction on the user (the so-called snob effect), so long as such behavior does not dominate the market for any commodity.

Partly because of the focus of economics on large-group behavior, economists can seldom use the method of laboratory experiment. (The few exceptions lie chiefly on the borderlines between economics and psychology; for example, subjects are given money to spend, gamble, or use in similar economic games.) The use of laboratory experiment is not, of course, a requisite of a science. Among natural sciences much of astronomy and meteorology are similarly disadvantaged. In economics the place of the laboratory experiment is largely taken by other methods of testing hypotheses, in which variables extraneous to the hypothesis being tested can, within limits, be held under statistical, rather than physical, control.

The use of statistical control of extraneous variables corresponds to the common theoretical device of “holding other things constant” in analyzing the functional relationship between two variables. For example, the statement that the consumption of milk increases in response to a fall in price can be represented as a demand curve, a downward sloping line on a graph whose vertical axis measures the price of milk and whose horizontal axis measures the rate of consumption. [SeeDemand and supply.] This relationship assumes that other factors affecting milk consumption, such as consumer income and tastes, do not change. A change in one of these factors will cause the demand curve to shift. A more complicated relationship, which expresses the rate of consumption as a function of both price and income, is often more useful and can be estimated statistically. Such a three-dimensional demand surface is hard to show graphically and is therefore less common in elementary expositions.

A more complete analysis of the market for milk would include the conditions of supply as well as of demand. The relationship between the price of milk and the quantity supplied (generally positive, or upward sloping) is known as the supply schedule or the supply curve. Together the supply and demand curves determine the quantity sold and the price. For given supply and demand conditions, the position so determined is a stable equilibrium position, and quantity and price will tend to return to it if the market is subjected to a small accidental disturbance. [SeeEconomic equilibrium.] However, if the disturbance changes the underlying conditions of demand or supply, the market will move to a different equilibrium position. For ex-ample, if the taste for milk changed so that people wanted it more than before, the result would prob-ably be a permanently higher consumption of milk, perhaps at a higher price.

The method that confines analysis to comparisons of the initial and final equilibrium positions of a market or system of markets is known as the method of comparative statics because it is not concerned with the path of the adjustment through time—that is, with such questions as whether milk consumption expands first quickly and then slowly in response to some initial impetus or expands at a steady rate. Dynamic analysis is concerned with the time path of movement. [SeeStatics and dynamics in economics.] For example, in a study of hyperinflation the time pattern of response to a previous increase in the price level is a crucial attribute of a satisfactory theory. Although “static” is sometimes used as a term of reproach and “dynamic” as one of praise, the choice between dynamic and static analysis must rest on the nature of the problem, with no general presumption that one is superior. Dynamic analysis requires additional knowledge about human behavior—knowledge that is not always available, for it involves knowing not only how people respond to economic stimuli, but at what rate.

As the foregoing observations suggest, economics makes extensive use of quantitative data and has a large body of abstract theory that can be extended and explored for consistency through the use of formal logic. For this reason economists began to use mathematics and statistics earlier and more intensively than most other social scientists. [The use of such methods in economics is discussed inEconometrics.]

We now turn to an overview of the substance of economics and in particular to the central problem of resource allocation. This will be approached through a classification of the functions of an economy devised by Knight (1933). Of his five functions, we shall consider four, designated here as: (a) determining the composition of output; (b) organizing production; (c) distributing the product (or income); and (d) providing for the future. (The fifth concerns the allocation of a fixed stock of goods over short periods of time.) Later we shall turn to the discussion of money, the price level, and the level of employment, which, as noted earlier, lie largely outside the resource-allocation framework.

Determining the composition of output

Modern societies determine what to produce in two basic ways—through political or governmental decisions and through the use of markets. These methods can be combined in varying proportions. Even in a country as noted for the use of markets as the United States, many important classes of goods and services—such as schools, roads, police protection, and national defense—are provided wholly or largely outside the market system in the sense that consumers pay for them through taxes rather than by the direct purchase of the services. The nonmarket sector is much larger in such socialist countries as the Soviet Union, and their reliance on the market to guide production decisions is usually weaker where markets are used. However, even the Soviet Union has a few legal private markets, particularly for perishable farm produce. The activities in which government services are provided without explicit charge are not coextensive with the government sector of an economy—for example, government post offices sell mail services to users by means of postage stamps (though not always at prices that cover costs), much as private businesses sell their services.

In the market sector, consumer preferences are transmitted to producers through decisions to purchase the goods and services offered for sale. (Producers may also use survey techniques or experimental markets to test consumer acceptance of new products [seeMarket research].) When consumers want more of a product that is sold on a free market, its price will tend to rise and its production will become more profitable. Existing producers will increase their output and new producers may enter the market. Conversely, if consumer desires for a product weaken, prices and output will tend to fall. [SeeDemand and supply] Although prices are in general the best signals to producers of changes in the pattern of demand, consumer preferences can also be transmitted through markets in which prices are fixed. In such markets, decreases in demand are indicated by unsold inventories of goods or by idle capacity to perform services; increases in demand are indicated by the disappearance of inventories and by queues. Most markets for consumer goods in socialist economies operate in this fashion, as do those monopolistic markets in capitalist economies in which prices are administered by sellers.

In socialist economies, decisions about the quantities of resources to devote to consumer goods are made centrally through government planning. Once these decisions are made, the planners have an incentive to heed market signals of surpluses and shortages and to allocate resources to particular products or to change product prices so as to achieve maximum consumer satisfaction with the allotted resources. However, the mechanisms for doing this in planned economies are not yet very successful. [SeeCommunism, economic organization of; andPlanning, economic, article Oneastern europe.]

An economy in which all markets were fully responsive to changes in consumer tastes would exemplify consumer sovereignty [seeConsumer sovereignty]. Complete consumer sovereignty under free enterprise would require the absence of monopolies, so that consumers could be provided with that amount of each commodity whose costs of production they were just willing to pay. (A monopoly would be able to restrict output below this level to obtain a price in excess of costs.) In equilibrium such a system would have the property, given the distribution of income, that the composition of output could not be changed without reducing the satisfaction of one or more consumers. Informative advertising would be permissible, or even desirable, but advertising that persuades without informing represents a departure from consumer sovereignty [seeAdvertising, article oneconomic aspects]. In principle, consumer sovereignty would be possible in a socialist economy if planners were willing to abide by decision rules that simulated the behavior of competitive markets.

The pattern of production resulting from consumer sovereignty depends not only on consumer tastes but also on the distribution of income and wealth. If income and wealth were redistributed more equally, there would be less production of goods and services consumed largely by the highest income groups (Cadillacs, domestic service) and by the lowest (potatoes, bus rides). Theoretically, there is less equality in decision making through the market than through democratic political processes, for in political elections each person has one vote, while in the market his “voting power” is proportional to his expenditures. The actual contrast is less sharp, for there are concentrations of political power as well, and not every citizen has equal influence on the outcome of political decisions.

An important advantage of a market system is that it characteristically provides for the tastes of minorities. It is often worthwhile for producers to make a product wanted by only a few people, provided that these few are willing to pay a little more than the price of a standard commodity. Consider, for example, the large number of different varieties, sizes, and shapes of bread offered for sale in a big city with a diverse population. By contrast, the provision of goods or services by governments has tended toward standardization and uniformity. Some critics of market economies view this variety as wasteful and argue that the efficiencies of standardization outweigh the importance of minor differences in tastes.

The market system also offers strong incentives to producers to develop new or improved products, in the hope that these will gain consumer acceptance and prove profitable. Innovation in consumer goods is a more conspicuous feature of market economies than of planned economies, although neither system can guarantee that innovations which would succeed will always be forthcoming.

Organizing production

Production is the combination of resources (factors of production) to produce desired output. Early in the history of economics the concept of production was associated with making physical products. Agriculture, mining, manufacture, and construction were considered productive activities, whereas transportation, trade, and such services as education were not. This distinction has long been abandoned. It is now recognized that transportation and trade add to the value of commodities by making them available where they are wanted and that furnishing services can contribute as much to the satisfaction of consumers as furnishing commodities [seeInternal trade].

Specialization and exchange and the division of labor are central concepts in the economics of production [seeSpecialization and exchange]. In undeveloped economies, much production is carried out by individuals and small groups (families, tribes, communities) which consume their own output. For example, in the early colonial period in North America, families usually grew or caught most of their own food, built their own houses, and made their own cloth, clothing, furniture, soap, and candles. In modern economies, most workers are specialized in the production of a particular commodity or service and usually perform a specialized task within the production process. Specialization increases output because workers acquire specialized skills and save time that would otherwise be spent in switching from one activity to another. Specialization usually enlarges the scale of production, and large-scale production justifies the use of expensive specialized tools and machinery. Moreover, the production of each good can be carried on in the most suitable locations. Although within some limits the division of labor undoubtedly increases output, it is sometimes argued that it deprives the worker of the satisfaction of creating a complete product and of variety in job content, thereby also diluting standards of craftsmanship and contributing to industrial unrest.

The possibility of specialization rests on the principle of relative advantage, which states that it is advantageous for a productive activity to be carried on by an inferior producer, provided that the superior producers are even more superior at doing something else. To take a familiar example, suppose that a doctor can mow his lawn in an hour, and the best gardener he can hire takes two hours. It will nevertheless pay him to hire the gardener at $2 an hour if he can earn $5 in an additional hour of medical practice. (We assume that the doctor attaches less than $1 an hour of recreational value to lawn mowing.) The principle just illustrated also underlies the specialization of production among nations and is therefore the cornerstone of the theory of international trade. [SeeInternational trade, article onTheory.]

Efficient production involves combining resources so as to minimize the cost of the output. We are all accustomed to partial measures of efficiency that relate useful output to the use of a single input— for example, miles per gallon of gasoline as a measure of the efficiency of an automobile. Partial measures of efficiency or productivity, such as output per man-hour, are also found in economics, but economists are usually more interested in the efficiency with which all resources together are used. A measure of this is “total factor productivity”— that is, useful output divided by the total input of economic resources, weighted by their respective prices or costs. [SeeProductivity.] This measure reflects the condition that it pays to conserve one factor by increasing the use of a second only if the added costs of the second factor are less than the value of the savings of the first. For example, an automobile that runs more miles per gallon is economically inefficient if the added cost of the better engine exceeds the cost of the gasoline saved over its lifetime, both valued at the same point in time.

Economists have long thought of resources, or inputs, in three traditional categories: land, labor, and capital. Land consists of the natural properties of soil, minerals, and climate; labor, of the current services (mental and physical) of humans; and capital, of such things as structures, machines, vehicles, livestock, inventories, and improvements to land such as clearing and terracing [seeCapital; Land; National wealth; Agriculture, article onCapital]. There is, however, nothing sacred about this particular trinity. The traditional factors are often very difficult to separate, as in the case of land and improvements to it. The factors can be more finely subdivided (for example, management can be distinguished from labor), or the scheme can be extended to recognize additional inputs, such as entrepreneurship [seeEntrepreneurship]. Humans can also be regarded as embodying investment made through education and training [seeCapital, human].

The relation between the combination of inputs in a production process and the resulting output is like a recipe in which labor, capital, and other classes of inputs replace such ingredients as butter, eggs, and milk. Such recipes are called production functions. [SeeProductionandEconomies of scale.] Cookbook recipes usually call for constant proportions of the various ingredients; in economic production, however, the proportions of inputs are generally varied in response to changes in factor prices so as to subst’lute less expensive for more expensive inputs. Although the possibility of substitution among factors may be limited by technology, it is often much greater than might at first be supposed. Steel mills in the United States, where labor is expensive, and in India, where labor is cheap, may use very similar basic production processes, yet Indian mills will find it economical to use much more labor and less capital in such auxiliary operations as materials handling.

For some purposes, the cost of an input is adequately represented by its market price. For others, one must turn to the more fundamental concept of opportunity cost, or alternative cost, which states that the cost of employing a unit of a factor of production in any activity is the output lost by the failure to employ that unit in its best alternative use. For example, the cost to the economy of changing the use of a tract of land on the outskirts of a city from farming to residences is represented by its value as farmland, which in turn depends on its contribution to farm output. However, if there were several residential or industrial development plans in each of which the value of the land was higher than in farming, the cost of using it in any one plan would be its highest value in any of the others. [SeeCost.]

Difficult problems arise when some of the outputs or inputs in a production process have no market value or when some of the costs of productive activity are not borne by the enterprise engaged in it. The evaluation of a proposal to convert farm-land near a city into a free public recreation area is essentially a question of judging whether the benefits exceed the costs. Production costs imposed on parties not engaged in the production process are exemplified by air and water pollution from industrial wastes, especially where the losses are so widely diffused that individual lawsuits to recover damages are impractical. [SeeExternal economies and diseconomies.] The presence of benefits or costs with no market valuation often leads to government regulation or intervention (such as the zoning of land or the prohibition of child labor) in the production processes of market economies.

In the classical period of economics, until about 1870, it was held that the cost of production determined the price or value of a commodity [seeValue, labor theory of]. The beginning of the neoclassical period is marked by the recognition that value is jointly determined by cost and by demand. The costs of producing a commodity often rise as total output is expanded and as resources less suited to its production are drawn into use. In such cases, an increase in demand requires the expansion of production into areas of higher costs and therefore causes an increase in price. However, changes in price can also arise on the supply side through changes in the underlying cost conditions, including changes in the supply of productive resources or in the technology of production, and through changes in the extent of monopoly power.

Once resources have been committed to a particular kind of production, they often cannot be easily withdrawn. For example, only a small fraction of the original construction cost of a railroad line could be retrieved as scrap value or from sale of the right of way. The remaining original construction costs, often called fixed costs or sunk costs, become irrelevant to day-to-day decisions about pricing and the nature of service. It will pay for the line to continue in operation if a pattern of prices and service is possible in which revenues cover current operating costs and interest on salvage value. Financial losses to the owners of specialized fixed capital are not social losses, and are not really costs, since such capital has no alternative use. As specialized capital equipment wears out, the costs of replacing it become relevant to decisions concerning the abandonment or continuation of the activity in which it is used. Analogous problems arise in the case of labor with specialized training.

The period within which some costs are fixed is called the short run; in the long run, all costs can be changed by changes in inputs. The length of the short run in chronological time varies with the nature of the production process and the durability of the capital goods used. It may be a hundred years for a hydroelectric project and a few weeks for an establishment making inexpensive cotton dresses.

Decisions about the organization of production also involve determining the lowest-cost location of productive facilities. Some kinds of facilities are located where raw materials are accessible (iron and steel mills, for example). Some activities take place close to sources of low-cost power (aluminum reduction and production of electrochemicals), others close to important markets for the product (automobile assembly), and still others where suitable labor is available or inexpensive (manufacture of garments). [SeeSpatial economics.]

Distributing income

The third basic function of an economy is to distribute income. In a society based on subsistence agriculture most income is distributed in kind; each family consumes largely the products of its own labor and land. In complex economies most income is distributed in money, representing generalized purchasing power or command over all goods and services offered for sale. The dominant use of money-income payments results from both specialization in production and the increasing variety of things consumed. The producer uses money income to purchase small quantities of many products, not necessarily including the one that he himself makes.

Income is the net value of production during a period—the amount available for consumption or net saving after initial wealth or capital has been maintained. In other words, income is the maximum amount that an economy (or an individual) could consume during a period without becoming poorer. If actual consumption is less than this, there has been saving during the period, and wealth has increased.

The functional classification of income depends on the kind of productive services furnished by the income recipient [seeIncome distribution, article onfunctional share]. Wages and salaries are the return for furnishing labor services, interest is the return for furnishing capital, and rent, in one sense of the term, is the return for furnishing land [seeWages; Interest; Rent]. (These categories are less neat in income statistics than in theory; a landlord who receives rent for a building, for example, is furnishing both land and capital.) The income share called profit is hard to identify with a particular factor of production. Much of what is called profit in both business and national accounts is a return to equity capital and corresponds to interest in economic theory. Some accounting profit represents a return to positions of monopoly power, sometimes called rent in another sense of the term. The residual, or “pure,” profit is regarded by some economists as the return to entrepreneurship or to innovation and by others as a return (either positive or negative) for taking noninsurable risks. [SeeProfit.]

Certain streams of payments to individuals, called transfer payments, do not correspond to any current contribution to production, but are claims of one set of individuals against the income of another. Public assistance is one example. The sum of wages and salaries, rent, interest, and profits exhausts the national income, and transfer payments arise from a secondary redistribution of these shares.

The basic principle of income distribution in a private enterprise economy is that individuals should receive as income the value of their contribution to production, including both the value of their labor and of the services of any productive land or capital that they own. This system gives each person an incentive to use his resources fully and where their contribution to the value of output is greatest. In practice, differences between the contribution of a factor to production and the income it receives can be caused by some kinds of imperfections in the markets for productive services. The income distribution is also modified by transfer payments, which are received largely by low-income groups; by the provision of free government services; and by taxes, particularly progressive personal income taxes. For most capitalist countries, these modifications seem to work on balance in the direction of greater equality of incomes.

The distribution of incomes in capitalist societies has long been criticized by socialists and reformers as too unequal. The best known competing principle is that of Marx: “From each according to his abilities, to each according to his needs.” No large, complex economy has ever operated on this principle for more than brief periods, although it may operate in certain religious orders and cooperative communities. Attempts to apply the Marxian principle have broken down because of two problems, assessing needs and maintaining incentives to work and to save.

The main difference between the principles of income distribution in contemporary capitalist and socialist countries lies in the treatment of nonlabor income. In both types of economies, workers are paid approximately in accordance with the value of their work. In the socialist countries, however, almost all productive capital is owned by the state, so that personal income from property is negligible. (In the Soviet Union some private income arises from interest on savings deposits and government bonds and from the private ownership of livestock by collective-farm families.) In capitalist economies, property income is much less equally distributed than labor income. It does not follow, however, that the distribution of income, as a whole, is more equal in socialist countries. In developed capitalist countries, labor income is the great bulk of total income; a somewhat less equal distribution of labor income in socialist than in capitalist countries could therefore offset the effect of the property share on the equality of total incomes and probably does offset much of it. However, there appears to be no counterpart in socialist economies to the very highest incomes under capitalism.

The distribution of income among persons is not only unequal but asymmetrical. Almost all income distributions are markedly skewed to the right; a concentration of individuals below the mean is balanced by a long “tail” much above the mean. Since natural abilities were long assumed to be symmetrically distributed and most income was seen as a return to various abilities, the skewness of real-world income distributions motivated much work by economists and statisticians. [SeeIncome distribution, article onsize; andSize distributions in economics.]

The major social problem related to the personal distribution of income is poverty, an older and more pressing concern of economists and sociologists. In economies at a low level of development, most peasants and unskilled workers are considered poor. In the highly advanced economies, relatively few families with employed male heads are considered poor; poverty is largely a problem of the aged, the disabled, the long-term unemployed, and households with female heads. However, there are exceptions. For example, in the United States there are a substantial number of poor farm families and poor Negro families headed by employed men. [SeePovertyandConsumers, article’onconsumption levels and standards.]

The definition of poverty has varied with time and place. In the United States in the mid-1960s, a widely accepted definition was that families with incomes below $3,000 a year were poor; about one-fifth of all families fell below this mark. In earlier times or in underdeveloped countries, the standard of living embodied in this definition would be viewed as comfortable or even luxurious. If the accepted poverty line moves upward as fast as average income, the elimination of poverty becomes exceedingly difficult. But however elusive the definition of poverty, the social problem is real and serious. Low income is a major factor contributing to crime, disease, and ignorance, which in their turn can give rise to new generations of the poor.

Policies to combat poverty fall in three general categories: public assistance or relief, rehabilitation and retraining, and the regulation of product and factor prices. Economists have tended to criticize the simplest forms of direct relief, once on the ground that they raised the natural rate of increase of poor populations and more recently on the ground that they weaken the incentive to work. Education, rehabilitation, and retraining have been preferred because they attack and sometimes eliminate a fundamental cause of poverty—the small actual or potential contribution of low-income workers to production. For the aged or disabled, social insurance is increasingly viewed as the best approach to assuring a decent minimum standard of living [seeAging, article onEconomic aspects].

Greater equality of income is also an announced objective of numerous public policies that directly alter product or factor prices. For example, agricultural price and income policies in many countries raise the incomes of farm families, which are usually lower than those of urban families. Such policies may increase the income of the favored sector, but often not that of the poorest families within it. Such policies also tend to restrict output or distort the allocation of resources, so that the choice is between a given national income unequally shared and a smaller one somewhat more equally shared. Indeed, the result is sometimes to lower income without increasing equality at all. [SeeAgriculture, article onprice and income policies; Subsidies.]

The demand for equalization policy is especially strong in times of war or disaster, when there is a general disposition to prevent the rich from bidding up the prices of goods in short supply. To achieve “fair shares” or “equality of sacrifice,” the role of money in the distribution of income is often supplemented by the direct rationing of certain scarce items on a per capita basis or to users whose needs are judged to be greatest. Such policies also have substantial efficiency costs, which may reduce the income available for distribution. [SeePrices, article Onprice control and rationing.]

Providing for the future

The fourth major function of any economy is to provide for the future through the conservation of natural resources, the maintenance or replacement of existing stocks of physical capital, and the net accumulation of capital. Increases in the stock of human skills and in the fund of accessible knowledge also are important in providing for the future.

The views of economists on conservation often clash with those of others, including natural scientists [seeConservation, article oneconomic aspects]. Two main kinds of conservation problems can be identified, the first of which arises when a resource, such as wild game or fish, cannot be owned. No hunter has an incentive to spare an animal today so that he may take it in the future, for if he fails to act now, the game may be taken by someone else. Conservation under these conditions requires such government controls as closed seasons and bag limits. Interesting economic problems arise in defining the optimum size of the population to be conserved.

Less severe policy problems arise where resources can be owned, as can land and solid minerals. (Oil and natural gas are an intermediate case.) If the owners of such a resource believe that it is becoming scarce and that few substitutes will be available, they have an incentive to conserve it in order to gain from the eventual rise in its price. The higher the cost of holding this asset, including the rate of return on alternative forms of wealth, the weaker will be this incentive. Nevertheless, overexploitation of resources can occur in such cases because of ignorance on the part of resource owners or because the interest rate confronting them does not correctly reflect the social cost of capital.

A larger part of the problem of providing for the future is that of maintaining and increasing physical capital. Capital is increased through saving, much of which is undertaken by individuals to provide for personal contingencies, such as illness and old age, and to accumulate wealth to bequeath to descendants or others. Saving is also undertaken because it yields income (interest), which corresponds to the productivity of capital in production. If the rate of interest is 6 per cent, refraining from consuming $100 of income this year will make possible consumption of $106 next year; alternatively it will make possible the consumption of an income stream of $6 in perpetuity. The return on capital provides both an incentive to accumulate and an incentive to refrain from using up present capital.

Investment provides capital for a growing population and also increases the amount of capital per person available to raise output per head. With unchanging technology the return on capital would tend to fall as the best investment opportunities were used up; however, this tendency is offset by technological changes that create new investment opportunities. The theoretical problems involved in measuring the stock of capital and discovering the principles that determine its yield are among the most difficult in economics. [SeeCapital.]

Determining the optimum rate of investment in a growing economy also raises difficult problems, which have received increasing attention in mathematical economic theory [seeInterestandEconomic growth, article onmathematical theory]. The crucial elements in this analysis are the rate of growth of population, the rate of return on capital, the rate of technological change, and the weights to be attached to the satisfaction of present and future generations.

Society requires many kinds of capital. One important way of classifying these distinguishes capital used in production from that used directly in consumption, such as houses, private automobiles, and home appliances [seeConsumers, article onconsumer assets]. A second important classification distinguishes the capital used in the production of a particular product, such as livestock, machinery, or factories, from capital—such as roads, water supply systems, communications facilities—that enters indirectly into the production of many products. The latter, called social overhead capital, is often publicly owned. [SeeCapital, social overhead.] Adequate provision for overhead facilities may be prerequisite to investment in the production of specific products.

Investment in new physical capital or the acquisition of existing physical assets by individuals, corporations, or governments often requires the investor to raise funds externally by borrowing or issuing shares. In the public mind the resulting financial assets, such as mortgages, bonds, and stocks, are more often identified with capital than are the underlying physical assets. Savings are made available for investment when financial assets are purchased by individual savers or by financial institutions, such as savings banks and insurance companies, in which savers hold their funds. [SeeFinancial intermediaries.]

A third important way of providing for the future is through technological change, including the discovery of new products and processes. Technological change in its broadest sense involves a wide range of activities: the growth of fundamental scientific knowledge through basic research, the invention of machines and methods, the dissemination and diffusion of knowledge through education, and the introduction of new methods in particular applications. An increased stock of knowledge is a more important legacy to succeeding generations than an enlarged stock of physical capital. New technology is usually incorporated, or “embodied,” in the stock of physical capital and in the skills of the labor force. [SeeInnovation; Research and development; Agriculture, article onProductivity and technology.]

So far our discussion of the functions of the economy has proceeded with little reference to money, yet all but the simplest economies would grind to a halt without this essential lubricant. Some specialization and exchange can take place with the aid of barter, the direct exchange of one commodity or service for another. However, barter requires that each party wants the exact kind and quantity of goods offered by the other, which would happen only by coincidence. Money, by freeing exchange from this coincidence of double demand, permits specialization to be greatly extended. The use of money as a medium of exchange therefore appears very early in economic development; money also furnishes the unit of account and, with other assets, serves as a store of value. [See the general article onMoney.]

Early money consisted of scarce commodities of various kinds, especially precious metals, and the minting of metals into coins was one of the earliest economic functions of the state. In modern economies, banknotes and other paper currency have replaced coins, except in small transactions. These notes were originally redeemable in gold or silver; this has now become uncommon. Paper currencies were once thought to derive their value only from their convertibility into metallic money; however, experience has not supported this belief. It is now clear that money derives its value from its usefulness as a medium of exchange and that irredeemable paper currencies can have stable or even rising value if their issue is restricted.

The largest part of money in developed economies consists of bank deposits, usually transferable by check. Banks, through their lending operations, can create and destroy money in the form of bank notes and deposits. Recognition of this has led to their regulation by central banks (usually agencies of the government) as a means of controlling the quantity of money and thus affecting its value. [SeeBankingandBanking, central.]

The value of money may be defined as the reciprocal of an index number of the general level of prices [seeIndex numbers, article onpractical applications]. Changes in the price level are important because not all individual prices are equally affected and relative prices and resource allocation are therefore influenced. In particular, changes in the price level affect the distribution of real wealth and income; a sustained rise in prices, or inflation, enriches net debtors at the expense of net creditors because the debt is stated in nominal or monetary units rather than in terms of command over real goods. A sustained fall in prices, or deflation, has the opposite effect. [SeeInflation and deflation.]

One of the best developed theories of the value of money is the quantity theory [seeMoney, article onquantity theory]. The demand for money, or cash balances, arises because money lowers the cost of making transactions. Recent formulations of the quantity theory express this demand as a function of real income or wealth, the expected rate of change of prices, the interest rate, and other variables. This function is thought to be reasonably stable in the long run, in which case the general level of prices is largely determined by changes in the quantity of money. Inflation results from sustained increases in the money supply relative to real income, and deflation from sustained decreases.

Changes in the demand for money under conditions of constant supply can often be inferred from the turnover rate of the money supply, usually called the velocity of circulation [seeMoney, article onvelocity of circulation]. A decreased desire to hold money would lead to a rise in velocity as holders sought to dispose of excess balances; an increased desire to hold money would lower velocity.

A decrease in the stock of money or its failure to grow as fast as productive capacity can cause, or contribute to, a fall in aggregate demand, output, and employment. Similarly, increases in aggregate demand brought about by increases in the stock of money or by other means will cause increases in output and employment when there is unused productive capacity. Once capacity is fully used, further increases in aggregate demand only raise the price level. Since capacity output will not be reached at the same moment in all branches of the economy, an intermediate zone exists in which increases in demand will increase output and prices simultaneously. However, behavior in this zone need not be symmetrical for increases and decreases in demand. A decrease in demand is likely at first to reduce output with little effect on prices.

As this suggests, money is a crucial element in economic fluctuations—the business cycle or the alternation of periods of prosperity and depression and of rising or falling prices—which have been one of the most conspicuous features of modern capitalist economies [seeBusiness cycles]. Economists have long studied the sequence of events in business cycles—the amplitudes of fluctuations, the length of expansions and contractions, and the leads and lags of turning points of series at cyclical peaks and troughs. Such observations have helped in the formation of theories of the causes of business cycles. Special attention has naturally been given to the causes of depression and widespread unemployment [seeEmployment and unemployment].

Interest in the construction of such macroeconomic theories was heightened by the great depression of the 1930s and in particular by the work of John Maynard Keynes. Central to Keynes’s thinking was the concept of deficiency of aggregate demand. If income receivers spent their entire incomes on consumption, such a deficiency could not arise; however, a portion of income is saved, and Keynes held that this portion rises as income rises. [See Consumption function.] Still, no problem arises if desired investment equals saving. All savings will then be spent in the purchase of new investment goods, and the flow of income will continue undiminished. But Keynes argued that this equality need not hold—unfavorable investment opportunities and high interest rates can lead to a reduction in desired investment and an excess of saving. [See Investment.] Under these circumstances, aggregate demand will fall short of productive capacity, real income will drop until saving is equal to desired investment, and there will be persistent unemployment. In Keynes’s view, governments should then create the required demand through an excess of government expenditures over tax receipts.

Until Keynes, orthodox economists had argued that unemployment was caused primarily by excessive wage rates and could be alleviated by wage cuts. Keynes assumed that in modern capitalist economies wages do not fall when output falls. In any case, his emphasis on the adequacy of demand led him to counsel against wage cuts. Wages, he pointed out, are incomes as well as costs, and their reduction could lower employment by diminishing the purchasing power of wage earners and their expenditures on consumption.

A crucial relationship in the Keynesian system is that between the quantity of money and the rate of interest, which takes a form that prevents the interest rate from falling below some minimum level. This “liquidity trap” implies that expansion of the money supply during a depression will fail to lower interest rates and therefore will not stimulate investment. [SeeLiquidity preference; for a discussion of the full Keynesian model, seeIncome and employment theory.]

During the 1930s, concern about aggregate demand stimulated work on systems of national income accounting that record the income and expenditures of the whole economy by sector [seeNational income and product accounts]. The simultaneous development of macroeconomic theory and macroeconomic accounting, among other forces, has led to a fundamental change in the attitude of governments toward depression and unemployment. It is now generally accepted that governments can, and should, act to maintain aggregate demand at levels as close as possible to productive capacity, although there are still important disagreements about the best ways of doing this under particular circumstances. The principal possibilities are to increase the quantity of money and hold down or reduce interest rates through expansionary policies of the central bank, to reduce taxes, and to increase government expenditure. [SeeMonetary policyandFiscal policy.] Opposite measures can be used to control inflation resulting from an excess of aggregate demand over capacity. The use of tax reductions or of increases in government expenditures as means of combatting deficient demand implies that the budgets of central governments should be in deficit in times of less than full employment.

The theory of resource allocation (microeconomic theory) and the theory of money, income, and the price level (macroeconomic theory) are the core of economics, whose outlines have been sketched above. Surrounding this core are several specialized fields. The mention of these here must be extremely brief, especially for fields described in single articles elsewhere in the encyclopedia.

Mathematical economic theory applies mathematical tools to theoretical problems in economics. Econometrics applies advanced statistical tools to empirical problems in economics. [For a survey of both fields, seeEconometrics.] Scientists in these fields have an international association, the Econometric Society.

The history of economic thought is the study of the work of past economists and their influence on one another, on other disciplines, and on the world of affairs. In this encyclopedia several schools of economics are discussed as such [seeEconomic thought]. However, the article on economic thought does not discuss the English and American classical and neoclassical schools, whose ideas are reflected in many substantive articles and whose leading figures are discussed in biographies [seeSmith, Adam; Ricardo; Millin the classical period;Marshall; Edgeworth; Jevons; Clark, John Bates, in the neoclassical period;Knight; Robertson; Pigouin more recent years]. Similarly, the Keynesian school of economics is included not under economic thought, but under substantive entries and biographies [seeKeynes, John Maynard; Hansen].

Economic history applies economic analysis to problems that are outside the recent past, although such problems often have implications for the present and future [seeHistory, article onEconomic history]. There has been a strong recent movement toward the application of econometric methods to economic history. Interest in the field has been stimulated by concern about the economies of underdeveloped nations and by the lessons those nations can learn from the economic history of developed areas. Economic historians have an active international association and several specialized journals. Closely related to economic history is the rapidly expanding field of economic development, which covers both the theory of growth and the more practical application of economics to the problems of less developed areas [seeEconomic growth].

Most other specialized fields in economics deal with problems of particular parts or aspects of the economy and the institutions peculiar to them.

Industrial organization considers problems arising from the structure of firms, industries, and markets. The firm is the entity that engages in production in the private sector of the economy. In simple economies, firms are owned by individuals or groups of partners, but large-scale economic activity is now carried out principally by corporations—firms that can be owned by many shareholders, who have no liability for corporate debts beyond the possible loss of value of their shares. Shareholders typically have little control over the affairs of the corporation; effective control is in the hands of professional managers. [SeeCorporation.]

An industry is the set of firms or establishments carrying out some branch of economic activity, although the boundaries of such a branch are not always easy to define usefully. A market in its simplest meaning is a place at which transactions are made; more broadly, it is the whole web of relationships between buyers and sellers. [SeeMarkets and industries.] The boundaries of markets, like those of industries, are often difficult to define.

A central concern of the field of industrial organization is the changes that take place in the character of markets as the number of buyers and sellers increases and as collusion among buyers or sellers becomes more difficult. At one extreme lies monopoly [seeMonopoly]. In principle, a monopoly is a market with only one seller, although all sellers are affected to some degree by competition from other markets. A monopolist in aluminum production, for example, would face the competition of other metals in some uses of his product. Markets dominated by a few sellers (oligopolies) raise interesting theoretical problems concerning interaction and collusion among the sellers, which are often approached through game theory [seeOligopoly]. At the other extreme are competitive markets with many sellers and buyers who do not collude [seeCompetition].

With given technology, competition promotes economic efficiency; monopoly or oligopoly tend to produce restriction of output and higher prices.

However, it is sometimes argued that monopoly is indispensable to technological progress. The advocates of this controversial view contend that very large corporations are necessary for innovation because modern research is too expensive to be carried on by small competitive firms [seeResearch and development].

Agricultural economics is concerned with the efficient use of resources in agriculture, the technology of food and fiber production, the distribution of farm products, and the income and welfare of farm populations [seeAgriculture]. Agricultural economists also study the migrations from rural areas that result from the high rate of natural increase of farm populations and the displacement of labor by improved farm technology. The organization of agricultural production differs sharply between different parts of the world—the family farm owned or rented by the operator, the large collective farm and state farm of the Soviet Union, the tropical plantation employing wage workers. The form of organization has important implications for efficiency and welfare. [SeeLand tenure; Communism, economic organization of; Plantations.]

Labor economics is both a branch of economics and of the interdisciplinary field of industrial relations. Although most of this broader field was once occupied by economists, it has increasingly attracted sociologists, psychologists, political scientists, and lawyers. Labor economists are therefore tending to specialize in the analysis of wages, hours of work, and employment [seeWages; Labor force, article onhours of work; Employment and unemployment]. They share with demographers an interest in labor force participation and also study government regulation of working conditions and the provision of social insurance and other wage supplements [seeAging, article onEconomic aspects; Labor force, article OnParticipation; Unemployment insurance; Workmen’s compensation].

A central institution in this field is the labor union—an association of workers formed to improve wages and working conditions through collective bargaining or political action [seeLabor relationsandLabor unions]. Although labor economists concentrate on the impact of unions on wages and employment, they are still concerned with the growth and internal functioning of unions.

Public finance applies economic analysis to the activities of the state and their impact on the private economy, particularly on the level of income and employment [seeBudgeting; Debt, public; Fiscal policy]. A major part of the field is the study of tax systems, including the effect of taxes on income distribution: whether they fall proportionally on all levels of income, are regressive (take a larger share of the lower incomes), or are progressive (take a larger share of the higher incomes) [seeTaxation]. Other studies of taxes deal with the effect of alternative tax systems on incentives to work, to save, and to use resources efficiently. Another part of the field deals with government expenditures—with determining the kinds of economic activity most appropriate to the state and devising criteria for deciding which particular public projects are worth undertaking [seePublic expenditures].

International economics extends economic analysis to the world economy. A country’s transactions with other countries are summarized in its balance of payments [seeInternational monetary economics, article onbalance of payments]. Some of these transactions are trade in commodities and current services, which reflects specialization among countries in production [seeInternational trade]. Economists study both the actual pattern of trade and the theoretical conditions underlying it; the theory of international trade is perhaps the best developed body of theory in any subfield of economics. The effect of tariffs or quotas on the world economy and on the nation imposing them is a central problem in international trade theory. [SeeInternational trade controls.]

Economics has grown rapidly in recent years, as measured either by the membership of professional associations or by the volume of professional literature. The American Economic Association was founded in 1885 and the Royal Economic Society (then the British Economic Association) in 1890. The former had fewer than 200 members in 1886; it passed the 2,000 mark in 1912. The largest increases, however, occurred between 1940 and 1962, during which time the American Economic Association grew from just over 3,000 members to more than 11,000. In 1959 there were about 5,000 fellows of the Royal Economic Society. As of 1964 there were 37 national economic associations affiliated with the International Economic Association, including 20 in Europe, 7 in Asia, and 6 in the Americas.

The growth of professional literature has been just as impressive. In 1961–1962 an Index of Economic Journals was published, covering only articles in English. It requires 270 pages to index the articles published in the 38 years between 1886 and 1924, and 533 pages for the 5 years between 1954 and 1959. The oldest journal covered is the Zeitschrift fur die gesamte Staatswissenschaft (Tübingen), founded in 1844. The next, the Quarterly Journal of Economics (Cambridge, Mass.), began in 1866. By 1900 there were seven—three in the United States, two in Germany, and one each in Britain and Sweden. The number of journals covered in 1961–1962 was 76, of which 29 were published in Europe, 24 in the United States and Canada, 19 in Asia, and 4 in Africa. The Index omits many more journals that publish no material in English.

Most economists are teachers in colleges and universities, although employment in business and government is increasing. Within universities most economists are in departments of economics, but in the United States there are also many on the faculties of schools of business, both graduate and undergraduate. Economists in business schools have worked closely with statisticians and applied mathematicians on problems of business decision theory and operations research.

Economists employed in business are sometimes engaged largely in descriptive statistics and public relations and have had little professional training. A growing number of business firms, however, employ economists with graduate training to do economic analysis.

Perhaps the fastest growing use of economists, almost everywhere, is in government—at all levels from municipalities to international organizations, but particularly in national governments. Economists are involved in a large number of different government functions. Many are involved in collecting and analyzing statistics and preparing statistical estimates such as national income accounts and prices indexes. Economists in central banks and treasuries or ministries of finance are engaged in formulating and executing monetary and fiscal policies. Still others in such agencies as budget bureaus or ministries of defense may be making cost–benefit analyses of public works projects or weapons systems. One of the most important roles of government economists is in central planning organizations, ranging from the very large and powerful central planning agencies of the communist countries, through the highly influential planning agencies of France and the Netherlands, to the largely advisory bodies like the Council of Economic Advisers in the United States.

An example may suggest the impact of changes in economic thought on government policy in the past three decades. In 1932, at the depths of the great depression, when the unemployment rate was over 20 per cent, the United States sharply increased the rates of a number of excise taxes and introduced several new ones in an effort to reduce the budget deficit. Shortly afterward John Maynard Keynes was to argue that such a policy would prolong a depression. In 1964 the United States reduced income taxes sharply in the face of a budget deficit because the unemployment rate of 5.7 per cent was unacceptably high, and it is probably not accidental that unemployment soon began to fall.

The contrast between these opposite policies illustrates strikingly the influence, in this instance a salutary one, of economic thought on policy. This influence is an important force drawing students into the discipline, but it also imposes on economists obligations to develop skills and judgment commensurate with their responsibilities.

Economics

New Dictionary of the History of Ideas
COPYRIGHT 2005 The Gale Group, Inc.

ECONOMICS.

The term economics, from the Greek oikonomika, means a science or art of managing the household. In modern usage, it refers to the efficient allocation of scarce resources in the production, distribution, and consumption of goods and services to satisfy various desires. As a branch of knowledge, economics or economic science is the study of how to efficiently use limited resources—natural resources (land), capital, labor, entrepreneurship, and information—to achieve maximum satisfaction of human material wants. Like other social sciences, economics studies human behavior but focuses on maximizing satisfaction or benefit as efficiently as possible or at minimum cost in the production, distribution, and consumption of goods and services. Hence, economics deals with decision making, theory, and management of the economy or economic systems. The decision makers or economic units of the economic system are households, businesses, and government.

Microeconomics is the branch of economics that deals with individual or specific economic units such as an individual industry, firm, or household and their interactions. In 1817, David Ricardo (1772–1823) wrote on the forces that determine the functional distribution of income and the theories of value and price, and it was from these theories that microeconomic theory originated. Microeconomics in the early twenty-first century includes the theory of consumer behavior, theory of production, and the theory of markets. It deals with such topics as prices of a specific product, the number of workers employed in a specific firm, the revenue or income of a particular firm or household, and the expenditures of a specific firm, government entity, or family. Microeconomic analysis focuses mostly on optimization and equilibrium analysis.

Macroeconomics deals with the aggregate economy and the behavior of its major units—households, businesses, government, and the foreign sector. Developed in the 1930s, macroeconomics was practically invented by the English economist John Maynard Keynes (1883–1946) in his attempt to develop an answer to the Great Depression. Keynes argued that the Great Depression was a problem of insufficient aggregate demand and that if the private economy could not generate sufficient demand, it was the government's responsibility to do so. Macroeconomics focuses on such issues as growth, recessions, inflation, unemployment, and government policy and deals with such topics as total output or gross domestic product (GDP), total employment, total income, aggregate expenditure, and general level of prices.

Historical Development

Although economics originally referred to the management of the affairs of the household (oikonomia in Greek), its meaning evolved into political economy—"[t]he financial branch of the art or business of government" (Milgate et al., eds., vol. 2, p. 58)—then into how to make a country wealthy, and finally into a social science that studies the production, distribution, and consumption of commodities.

The economic problem or the objective of the economic arrangement, be it in a primitive hunting and gathering society or in the most sophisticated modern industrial society, is that of provision—how to use scarce resources to produce goods and services and how to appropriately distribute the product. This problem has remained basically unchanged in human history. Over time, what has differed or changed are the modes of economic organization that correspond to the cultural arrangements in human societies. But the existence of the economic problem is different from an analysis of the economic problem. Organized economic systems existed in ancient Egypt, the great African empires of Western Sudan, the Aztec and Incan civilizations of the Americas, and the Assyrian and Babylonian theocracies. But according to Joseph Schumpeter, there is no trace of analytic effort until Greece. Even the beginning of the analytic effort did not become systematic until the eighteenth century. Hence, as a field of study, economics is relatively young, and only emerged as a full-fledged separate discipline following the publication of Adam Smith's The Wealth of Nations in 1776.

In Western civilization wealth was the primary and original concern of economics, and in economics the questions about wealth concerned the means of acquiring, maintaining, and increasing it. Wealth was seen by Aristotle not as an end, but as a means of achieving ethical and political ends. Whereas the treatment of wealth in the noneconomic fields of religion, history, politics, and the like focused mostly on its distribution and its effect on affluence, poverty, and the state, the approach of the economists was to focus on the means to wealth.

In addition to the attempts to understand the sources of wealth, pioneer economists sought to understand human nature and the sources of value. Human nature has been viewed both in the traditional conservative view as natural and pre-ordained and in the critical liberal view as socially determined. The traditional conservative view from the Middle Ages through slavery in the Americas and the industrial revolution sees ideas, drives, and practices as natural, inherent, God-given, or innate. Hence, the classical and neoclassical economists believed that capitalism was natural and eternal and consumer preferences were given, since individuals were born with them in the same manner that the conservative religious leaders believed that serfdom was natural and the American conservative southerners believed that slavery was ordained by God. Critical economists or the liberal view originating from Karl Marx (1818–1883), Thorstein Veblen (1857–1929), and John Maynard Keynes focused more on the evolution and transformation of economic systems and their impact on people's ideas and preferences. This premise was based on the belief that ideas and preferences are shaped by the society in which people live (Hunt and Sherman).

With all its accomplishments, economics is plagued with a crisis of identity and dissension and disagreements on how it should be taught, how it should be practiced, and how it should be used. Furthermore, the field of economics has been slow in reintegrating itself into the social sciences to become, once again, more problem-driven and more eclectic. Indeed the shift to abstraction and quantification that was started by David Ricardo continued until relatively recently and is at the source of the dispute about the usefulness of economics in modern society. Many economists complain about an undue attention paid to esoteric models, and the tendency by some economists, mostly of the orthodox school, to provide a uniquely economic answer to such social questions as the causes of growth and why some countries are underdeveloped.

Undeniably, as the twentieth century drew to a close, there was a greater recognition of the importance of noneconomic factors in explaining major economic questions and problems. For instance, mainstream economics has come to acknowledge the importance of history, political conditions, sociocultural factors, the environment, geography, and international variables in explaining such economic problems as lack of growth, underdevelopment, inequality, and poverty. This recognition notwithstanding, the field of economics has still not seriously focused on the critical and endemic problems that plague the world. For instance, despite being the least developed continent in the world representing arguably the most daunting economic challenge in modern history, Africa has been all but ignored by economics. This is amazing in light of the fact that the field's supposedly central preoccupation is the problems of income, growth, distribution, and human welfare.

Notable contributions to the field of economics include Richard Cantillon's Essay on the Nature of Commerce (1755), Adam Smith's Wealth of Nations (1776), Karl Marx's Das Capital (1867), Thorstein Veblen's The Theory of the Leisure Class (1899), and John Maynard Keynes's General Theory of Employment, Interest, and Money (1936). Before the publication of the Wealth of Nations, there were other schools of thought whose main preoccupation was wealth creation and the organization of the economy, most prominently, mercantilism and physiocracy.

Mercantilism or bullionism.

Mercantilism or bullionism is a loose economic school of thought whose basic belief is that a nation's wealth originated from gold and silver bullion and other forms of treasure. The mercantilist ideas were spread in an uncoordinated three-hundred-year effort, mostly through the English pamphlet writers of the seventeenth and eighteenth centuries, a period marked by significant shortages of gold and silver bullion in Europe. Mercantilism believed in trade regulation, industrial promotion, imposition of protective duties on imports of manufactures, encouragement of exports, population growth, and low wages. This belief in regulating wealth was grounded in the conviction that favorable balance of trade leads to national prosperity.

Mercantilists assumed that the total wealth of the world was fixed and reasoned that trade would lead to a zero-sum game. Consequently, they surmised that any increase in the wealth and economic power of one nation was necessarily at the expense of other nations. Hence, they emphasized balance of trade as a means of increasing the wealth and power of a nation.

Physiocracy.

The term Physiocracy (the order or rule of nature) developed for less than two decades as a reaction against the doctrines and restrictive policies of mercantilism. Founded on a doctrine of noninterference, the physiocratic ideas were first enunciated by the Frenchman François Quesnay (1694–1774). Quesnay argued that only agriculture can produce net output (produit net ). According to Physiocracy, the farmers and landowners were considered to be the productive classes whereas the merchants and industrialists were not. The Physiocrats believed in natural laws, the free enterprise system, and the free operation of the natural order of things. Quesnay also developed the famous Tableau Economique (economic table) in an attempt to establish a general equilibrium through a basic input-output model. The main ideas of Physiocracy that were promoted by the intellectual disciples of Quesnay—a group of French social reformers—came directly or indirectly from his Tableau Economique. Another important contributor to Physiocracy is Anne-Robert-Jacques Turgot (1727–1781), whose Reflections on the Formation and the Distribution of Wealth (1769–1770) was one of the most important general treatises on political economy written before Smith's Wealth of Nations.

Major Theories

The study of economics is driven by theories of economic behavior and economic performance, which have developed along the lines of the classical ideas, the Marxist idea, or a combination of both. In the process, various models were developed, each trying to explain such economic phenomena as wealth creation, value, prices, and growth from a separate intellectual and cultural setting, each considering certain variables and relationships more important than others. Within the aforementioned historical framework, economics has followed a trajectory that is characterized by a multiplicity of doctrines and schools of thought, usually identifiable with a thinker or thinkers whose ideas and theories form the foundation of the doctrine.

Classical economics.

Classical economic doctrine descended from Adam Smith and developed in the nineteenth century. It asserts that the power of the market system, if left alone, will ensure full employment of economic resources. Classical economists believed that although occasional deviations from full employment result from economic and political events, automatic adjustments in market prices, wages, and interest rates will restore the economy to full employment. The philosophical foundation of classical economics was provided by John Locke's (1632–1704) conception of the natural order, while the economic foundation was based on Adam Smith's theory of self-interest and Jean-Baptiste Say's (1767–1832) law of the equality of market demand and supply.

Classical economic theory is founded on two maxims. First, it presupposes that each individual maximizes his or her preference function under some constraints, where preferences and constraints are considered as given. Second, it presupposes the existence of interdependencies—expressed in the markets—between the actions of all individuals. Under the assumption
of perfect and pure competition, these two features will determine resource allocation and income distribution. That is, they will regulate demand and supply, allocation of production, and the optimization of social organization.

Led by Adam Smith and David Ricardo with the support of Jean-Baptiste Say and Thomas Robert Malthus (1766–1834), the classical economists believed in Smith's invisible hand, self-interest, and a self-regulating economic system, as well as in the development of monetary institutions, capital accumulation based on surplus production, and free trade. They also believed in division of labor, the law of diminishing returns, and the ability of the economy to self-adjust in a laissez-faire system devoid of government intervention. The circular flow of the classical model indicates that wages may deviate, but will eventually return to their natural rate of subsistence.

Marxist economics.

Because of the social cost of capitalism as proposed by classical economics and the industrial revolution, socialist thought emerged within the classical liberal thought. To address the problems of classical capitalist economics, especially what he perceived as the neglect of history, Karl Marx (1818–1883), a German economic, social, and political philosopher, in his famous book titled Das Kapital or Capital (1867–1894) advanced his doctrine of dialectical materialism. Marx's dialectics was a dynamic system in which societies would evolve from primitive society to feudalism to capitalism to socialism and to communism. The basis of Marx's dialectical materialism was the application of history derived from Georg Wilhelm Friedrich Hegel (1770–1831), which maintained that history proceeds linearly by the triad of forces or dialectics called thesis, antithesis, and synthesis. This transition, in Marx's view, will result from changes in the ruling and the oppressed classes and their relationship with each other. He then envisaged conflict between forces of production, organization of production, relations of production, and societal thinking and ideology.

Marx predicts capitalist cycles that will ultimately lead to the collapse of capitalism. According to him, these cycles will be characterized by a reserve army of the unemployed, falling rate of profits, business crises, increasing concentration of industry into a few hands, and mounting misery and alienation of the proletariat. Whereas Adam Smith and David Ricardo had argued that the rational and calculating capitalists in following their self-interest promote social good, Marx argued that in rationally and purposefully pursuing their economic advantage, the capitalists will sow the seeds of their own destruction.

The economic thinking or school of economic thought that originated from Marx became known as Marxism. As the chief theorist of modern socialism and communism, Marx advocated fundamental revolution in society because of what he saw as the inherent exploitation of labor and economic injustice in the capitalist system. Marxist ideas were adopted as the political and economic systems in the former Soviet Union, China, Cuba, North Korea, and other parts of the world.

The neo-Marxist doctrines apply both the Marxist historical dimension and dialectics in their explanation of economic relationships, behavior, and outcome. For instance, the dependency theory articulates the need for the developing regions in Africa, Latin America, and Asia to rid themselves of their endemic dependence on more advanced countries. The dependency school believes that international links between developing (periphery) and industrialized (center) countries constitute a barrier to development through trade and investment.

Neoclassical economics.

The period that followed Ricardo, especially from 1870 to 1900, was full of criticism of classical economic theory and the capitalist system by humanists and socialists. The period was also characterized by the questioning of the classical assumption that laissez-faire was an ideal government policy and the eventual demise of classical economic theory and the transition to neoclassical economics. This transition was neither spontaneous nor automatic, but it was critical for the professionalization of economics.

Neoclassical economics is attributed with integrating the original classical cost of production theory with utility in a bid to explain commodity and factor prices and the allocation of resources using marginal analysis. Although David Ricardo provided the methodological rudiments of neoclassical economics through his move away from contextual analysis to more abstract deductive analysis, Alfred Marshall (1842–1924) was regarded as the father of neoclassicism and was credited with introducing such concepts as supply and demand, price-elasticity of demand, marginal utility, and costs of production.

Neoclassical or marginalist economic theories emphasized use value and demand and supply as determinants of exchange value. Likewise neoclassicals, William Stanley Jevons (1835–1882) in England; Karl Menger (1840–1925) in Austria; and Léon Walras (1834–1910) in Switzerland, independently developed and highlighted the role of marginal utility (and individual utility maximization), as opposed to cost of production, as the key to the problem of exchange valuation. Neoclassical models assume that everyone has free access to information they require for decision making. This assumption made it possible to reduce decision making to a mechanical application of mathematical rules for optimization. Hence, in the neoclassical view, people's initial ability to maximize the value of output will, in turn, affect productivity and determine allocation of resources and income distribution. Neoclassical economics is grounded in the rejection of Marxist economics and on the belief that the market system will ensure a fair and just allocation of resources and income distribution.

Since its emergence, neoclassical economics has become the dominant economic doctrine in the study and teaching of economics in the West, especially in the United States. A host of economic theories have emerged from neoclassical economics: neoclassical growth theory, neoclassical trade theory, neoclassical theory of production, and so on. In the neoclassical growth theory, the determinants of output growth are technology, labor, and capital. The neoclassical growth theory stresses the importance of savings and capital accumulation together with exogenously determined technical progress as the sources of economic growth. If savings are larger, then capital per worker will grow, leading to rising income per capita and vice versa.
The neoclassical thinking can be expressed as the Solow-Swan model of the production function type Y F (N, K ) which is expanded to ΔY /Y = ΔA /A + ΔN /N + ΔK /K where Y represents total output, N and K represent the inputs of labor and capital, and A represents the productivity of capital and labor, and ΔY /Y, ΔA /A, ΔN /N, and K / K represent changes in these variables, respectively.

The Solow-Swan model asserts that because of the diminishing marginal product of inputs, sustained growth is possible only through technological change. The notion of diminishing marginal product is rooted in the belief that as more inputs are used to produce additional output under a fixed technology and fixed resource base, additional output per unit of input will decline (diminishing marginal product). This belief in the stationary state and diminishing marginal product led neoclassical economics to believe in the possibility of worldwide convergence of growth.

Known also as the neoliberal theory, neoclassical economics asserts that free movement of goods (free trade), services, and capital unimpeded by government regulation will lead to rapid economic growth. This, in the neoclassical view, will increase global output and international efficiency because the gains from division of labor according to comparative advantage and specialization will improve overall welfare. Even modern trade models (such as the Hecksche-Ohlin) are based on the neoclassical trade theory, which assumes perfect competition and concludes that trade generally improves welfare by improving the allocation of factors of production across sectors of the economy.

Rational expectation.

Rational expectation is the economic doctrine that emerged in the 1970s that asserts that people collect relevant information about the economy and behave rationally—that is, they weigh costs and benefits of actions and decisions. Rational expectation economics believes that because people act in response to their expectations, public policy will be offset by their action. Also known as the "new classical economics," the rational expectation doctrine believes that markets are highly competitive and prices adjust to changes in aggregate demand. The extent to which people are actually well informed is questionable and prices tend to be sticky or inflexible in a downward direction because once they go up, prices rarely come down. In the rational expectation doctrine, expansionary policies will increase inflation without increasing employment because economic actors—households and businesses—acting in a rational manner will anticipate inflation and act in a manner that will cause prices and wages to rise.

Monetarism.

Like rational expectations theory, monetarism represents a modern form of classical theory that believes in laissez-faire and in the flexibility of wages and prices. Like the classical theorists before them, they believe that government should stay out of economic stabilization since, in their view, markets are competitive with a high degree of macroeconomic stability. Such policies as expansionary monetary policy will, in their view, only lead to price instability. The U.S. economist Milton Friedman, who received the Nobel Prize in 1976, is widely regarded as the leader of the Chicago school of monetary economics.

Institutionalism.

Institutional economics focuses mainly on how institutions evolve and change and how these changes affect economic systems, economic performance, or outcomes. Both Frederick Hayek and Ronald Coase, major contributors to the Institutionalist School in the tradition of Karl Marx and Joseph Schumpeter, look at how institutions emerge. Hayek examines the temporal evolution and transformation of economic institutions and concludes that institutions result from human action. Hence, he suggests the existence of a spontaneous order in which workable institutions survive while nonworkable ones disappear. Coase believes that institutions are created according to rational economic logic when transaction costs are too high. Other notable contributors to institutionalism include Thorstein Veblen, Clarence Ayers, Gunnar Myrdal, John R. Commons, Wesley Cair Mitchell, and John Kenneth Galbraith.

The New Institutionalism, represented mostly by Douglas North, Gordon Tullock, and Mancur Olson, uses the classical notions of rationality and self-interest to explain the evolution and economic impact of institutions. It considers such issues as property rights, rent-seeking, and distributional coalitions and argues that institutional transformation can be explained in terms of changes in property rights, transaction costs, and information asymmetries.

Themes

As an academic discipline, economics encompasses a wide variety of themes that represent its historical and contemporary intellectual development. Some of the discipline's major themes include economic methodology, development economics, Endogenous Growth theory, feminist economics, environmental economics, monetarist economics, and econometrics.

Economic methodology.

Economic methodology refers to the method of economic investigation. It mirrors and derives from economic theory and has come to be known as the formulation and testing of hypotheses of cause-and-effect relationship. Like the field itself, which is very much in dispute, economic methodology has evolved and transformed in time from a more formal scientific approach in which methodology was emphasized to a period of lesser emphasis on scientific methodology. Before the formalization of economic theory, economists employed discourse to state and test theories and hypotheses. This heuristic approach did not permit hypothesis to be tested in a manner acceptable as scientific.

In time, economics adopted the use of the scientific method to either formulate economic laws, theories, or principles or to ascertain their validity. The process involves observing facts, making assumptions and hypothesizing about facts, testing hypotheses (to compare outcomes with predictions), accepting or rejecting hypotheses, systematically arranging and interpreting facts to draw generalizations and establish laws, theories, or principles, and often formulating policies, addressing economic problems, or achieving specific economic goals.

At the two levels of microeconomics and macroeconomics, economic methodology can either be inductive or deductive,
quantitative or qualitative, positive or normative. Economists express economic theory in terms of equations and relationships between economic variables in algebraic form and make inferences using mathematical operations. Over time, the economics discipline has witnessed an intensified mathematization of economic methodology and an increased role of abstraction and esoteric modeling that has, in effect, made it inaccessible to the untrained.

In this regard, econometrics, especially linear regression analysis, mathematical economics, game theory, and the like have played a great role. There has also been a move away from the scientific methodology involving data collection, hypothesis, analysis, and theory to an emphasis on modeling.

The 1960s and 1970s saw enormous advances in formal statistical testing and logical positivism and Popperian falsification, mostly in an attempt to establish one correct method of economics. Karl Raimund Popper (1902–1994) is one of the most influential philosophers of the twentieth century who produced influential works and political philosophy, particularly The Logic of Scientific Discovery (1959). Falsification is "a methodological standpoint that regards theories and hypotheses as scientific if and only if their prediction are at least in principle falsifiable, that is, if they forbid certain acts/states/events from occurring" (Blaug, 1992, p. xiii).

Development economics.

Development economics or the economics of development is the application of economic analysis to the understanding of the economies of developing countries in Africa, Asia, and Latin America. It is the subdiscipline of economics that deals with the study of the processes that create or prevent economic development or that result in the improvement of incomes, human welfare, and structural transformation from a predominantly agricultural to a more advanced industrial economy. The subfield of development economics was born in the 1940s and 1950s but only became firmly entrenched following the awarding of the Nobel Prize to W. Arthur Lewis and Theodore W. Schultz in 1979. Lewis provided the impetus for and was a prime mover in creating the subdiscipline of development economics.

As a subfield concerned with "how standards of living in the population are determined and how they change over time" (Stern), and how policy can or should be used to influence these processes, development economics cannot be considered independently of the historical, political, environmental, and sociocultural dimensions of the human experience. Hence development economics is a study of the multidimensional process involving acceleration of economic growth, the reduction of inequality, the eradication of poverty, as well as major changes in economic and social structures, popular attitudes, and national institutions.

Development economics covers a variety of issues, ranging from peasant agriculture to international finance, and touches on virtually every branch in economics: micro and macro, labor, industrial organization, public finance, resource economics, money and banking, economic growth, international trade, etc., as well as branches in history, sociology, and political science. It deals with the economic, social, political, and institutional framework in which economic development takes place.

The study of economic development has been driven by theories of economic development, which have developed along the lines of the classical ideas, the Marxist idea, or a combination of both. Some approaches have focused on the internal causes of development or underdevelopment, while others have focused on external causes. Economic growth—increase in output and income—has been used as a substitute for development and, in some cases, has been treated as synonymous with development. Economic growth and economic development have been mostly studied by means of cross-country econometric analysis.

Development economics has an assortment of theories and models to inform its teaching and research—neoclassical, Marxist, demand-driven, balanced growth, unbalanced growth, stages of growth, structuralist, dependency, neoclassical, and endogenous—each trying to explain development from a separate intellectual and cultural setting, each considering certain variables and relationships more important than others. Kaushik Basu identifies three major surges in economic growth theory in this century: the Harrod Domar model and the responses it orchestrated, the neoclassical response to Harrod Domar led by Solow (1956), and the works of Lucas (1986) and Romer (1988) that gave rise to the theory of endogenous growth.

Endogenous growth theory.

Proponents of the endogenous growth theory focus on technological progress and innovation and believe that technological change is endogenous, not exogenous, as neoclassical economics claims. Originally developed by Frankel, and then Lucas and Romer, endogenous growth theory argues that in addition to the accumulation of capital, technical progress is not exogenous but is planned and produced through research and development efforts. It recognizes the role of private sector and free market enterprise as the engine of growth, but suggests an active role of public policy in promoting economic development. In sum, in endogenous growth economics, several factors come together to determine the level of output in a country: government policy, economic behavior, and technology, which are determined by the expenditure on research and development, the rate of accumulation of factors of production—land, labor, capital, entrepreneurship, and savings. One could summarize the entire focus as being to explain the existence of increasing returns to scale and divergent long-term growth patterns among countries.

Feminist economics.

Feminist economics is the branch of economics that advances a theory of economic equality of the sexes and deals with gender equality or the elimination of gender subordination. Feminist economics originated from the organized feminist activities and movement whose influence became more visible in the 1970s and 1990s on behalf of women's rights and interest. It continues to exert an increasing influence on the field of economics by questioning the existing paradigms, approaches, and assumptions.

Through journals and feminist publications, feminist economists criticize what they refer to as the social construction of economics as a discipline, in particular neoclassical orthodoxy. They highlight what they consider to be the androcentric (male-centered) nature of conventional economic thinking,
question its wisdom, and reveal biases in conventional microeconomic models. Feminist economists question the nature and functioning of the markets and the classical market society, especially with regard to economic rationality and maximizing behavior. They also highlight the absence of power relations and unequal exchanges, gender, and race in mainstream economic analysis. They question the focus on choices in mainstream analysis and advocate focusing, instead, on provisioning, which, in their view, would account for such social issues as poverty and income inequality. Feminist economics also indicts the lack of emphasis on women's economic role and the noninclusion of domestic and other unpaid work in national income accounts and statistics.

Environmental economics.

Environmental economics is the branch of economics that deals with the application of economic tools and principles to the understanding and analysis of environmental issues and to solving environmental problems. Environmental economics draws from both microeconomics and macroeconomics, focusing on individual decisions that have environmental consequences and changes in institutions and policies to achieve desirable environmental goals.

A major preoccupation of environmental economics is the question of externalities or spillovers, especially negative externalities or spillover costs of human action. The cost of and responses to pollution, emissions, and other negative externalities as well as population, natural resources, energy, water, agriculture, forests, and wildlife are issues considered in environmental economics. Likewise, environmental economics deals with economic dimensions of problems of both regional and global pollutants, including acid rain, ozone depletion, and global warming.

Environmental economics involves the valuation of the environment and natural resources as well as the assessment of environmental damage, management, and regulation of environmental risk, and the markets for the environment. Environmental economics takes account of sustainable development and the impact on the environment of trade, transport, deforestation, water pollution, and climatic change. It also involves analysis of the costs and benefits of the environment.

Mathematics and economics.

Mathematical economics involves the use of formal and abstract analysis to develop hypotheses and analyze economic relationships. It refers to the application of mathematical techniques to the formulation of hypotheses and building economic models. The introduction of mathematics into economics by the Frenchman Antoine Augustin Cournot (1801–1877) in 1838 marked the beginning of a steady course that led to the emergence of mathematical economics. The antecedents of Léon Walras in 1874–1877 and Vilfredo Pareto in 1896–1897 were also essential in advancing mathematical economics. Henceforth, geometrical figures became conventional in economic literature and so did differential calculus and linear algebra. Game theory—the application of mathematics to the analysis of competitive situations and actions—has become a popular aspect of mathematical economics following the publication of The Theory of Games and Economic Behavior in 1944 by John von Neumann and Oskar Morgenstern.

Econometrics.

Econometrics is the application of mathematical and statistical techniques to the testing of hypotheses and quantifying of economic theories and the solution of economic problems. Econometrics combines mathematical economics as it is applied to model-building and the hypothesis-formulation and statistical analysis involving data collection, analysis, and hypothesis-testing. The emergence of econometrics has provided economists with a tool for analyzing macroeconomic models for forecasting, simulation, and economic policy.

As the most widely used tool for empirical analysis and for constructing theories, econometrics provides a method that allows the expression of economic theory using statistical data or using statistical data to estimate economic theory. Estimation methods range from Ordinary Least Squares to panel data and time series analysis.

New methodological approaches have been developed to address some of the weaknesses of the traditional methodology. For instance, there is more emphasis on rigorous diagnostic testing, including coefficient, residual, and stability tests as well as Unit Root and Johansen tests for cointegration and Granger Causality test. Cointegration analysis of time series to determine whether a group of nonstationary series are cointe-grated is an important development in empirical modeling. Improvements in multiple regression analysis often involving tests of correlation and causality as well as linear and nonlinear regression methods have proved to be important for the development of econometrics.

Global Organization and Orientation

Between the two world wars, two important phenomena affected the organization and orientation of economics in the world. The first was the Bolshevik Revolution of 1917 and the exceptionally rapid industrialization of the Soviet Union. The second was the Great Depression of the 1930s. The former led to the development of the Marxist-Stalinist economic system and state-directed development, collectivization, and the establishment of a command economy. The Great Depression led to a declining faith in the classical (laissez-faire) self-regulating free market capitalism, and the emergence of government interventionism, following the publication, by John Maynard Keynes in 1936, of The General Theory of Money, Interest, and Employment.

The new field of development economics was born in the 1940s and 1950s with W. Arthur Lewis providing the impetus for and being a prime mover in creating the subdiscipline. The new Keynesian macroeconomics and development economics advocated widespread government intervention in the economic process. Likewise, the powerful and far-reaching movements of the developing countries in Africa, Asia, and Latin America in the 1940s gave rise to the rejection of free-market capitalism in those regions. In the 1940s and 1950s, economists advocated for a dominant role of the state and comprehensive national development planning was recommended as a way to eliminate the "vicious circle of poverty" and underdevelopment. The advocacy for dirigisme was founded on the notion of market segmentation and failures as well as on information asymmetries and resource constraints. Disappointing results after World
War II forced a serious questioning and tempering of this development dirigisme.

As a social science, economics is subject to ideological manipulation. Aside from the orthodox (mainstream) and heterodox spheres, in the neoclassical intellectual tradition, there has been a split since the late nineteenth century as can be seen in the case of its liberal and conservative wings. Led by Paul Samuelson, liberal thinking is associated with advocacy for government intervention to correct market imperfections and market failures while conservatism or neoclassicism led by Milton Friedman is associated with a more pronounced advocacy for laissez-faire.

Impact of Influential Economic Ideas

Throughout the history of nations, economic ideas, notably those of Adam Smith, Karl Marx, and John Maynard Keynes, have had a profound influence on politics and society. Economics has influenced the emergence of political systems, political ideology, and the societal organization of production and distribution. The political and economic systems of democratic capitalism and socialism owe their existence to the ideas of Adam Smith and his followers and Karl Marx, respectively. Recognizing this fact, Keynes, in a famous passage from chapter 24 of General Theory of Employment, Interest, and Money, states: "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist."

Adam Smith's invisible hand of competitive markets, self-interest, and division of labor gave rise to the American style of individualistic market capitalism. Smith's notion of the natural tendency of an economic system to establish equilibrium through the pursuit of self-interest and competitive markets became the foundation of liberal economics in the nineteenth century. Likewise, Marx's analysis of capitalism, his prediction of its ultimate demise, and the triumph of socialism and communism became the foundation for the socialist economic systems of the former Soviet Union and other Eastern European, African, and Asian countries. His idea of the inevitability of the historical evolution of societies from primitive society to feudalism to capitalism to socialism, and ultimately to communism due to the internal conflicts resulting from the exploitation of workers, led to socialist ideas of centralization, planning, and public ownership of resources.

The commitment by governments to macroeconomic policies that ensure full employment and economic growth; the establishment of social security systems; and even deposit insurance guarantees in the banking system are all by-products of influential economic ideas of Keynes. Keynes argued that the answer to the existence of the Great Depression was insufficient aggregate demand and recommended increase in public demand by the government as a means of increasing total demand and output. Since then, discretionary macroeconomic stabilization has become a policy goal of many countries.

Much of the distinction between political conservatism and liberalism is based on economics and in this regard, the differentiation lies on the belief of the role of government versus the market and what type of government intervention, if any, will bring about the most optimum outcomes. In the United States, for instance, liberal politicians tend to favor government spending over lower taxes, while conservative politicians tend to favor tax reductions over government spending as fiscal policy measures against economic recessions.

Economy and Society

The discipline of economics commonly focuses on only one aspect of social life—how people employ scarce resources to produce, distribute, and exchange goods and services for consumption. Economists acknowledge that there are other aspects—political, legal, educational, for instance— and that these aspects influence economic life significantly. However, they usually assume that, for purposes of economic analysis, these influences are constant and thus do not modify economic processes; or, as it is often put, tastes and institutions are “given.” By thus limiting the number of variables they study, economists have been able to advance their science, but they have also greatly oversimplified the relations between economic and other types of social variables.

The field of economic sociology relaxes, as it were, these stringent assumptions about the relations between economic and other types of social variables and explicitly focuses on explaining variations in the ways these different types of variables impinge on one another. For example, in studying wages the economist concentrates mainly on the features of the market that influence and are influenced by wage levels, whereas the sociologist inquires into a wider range of causes and consequences. If management, for instance, persistently tinkers with wage levels, the sociologist may find out that this strengthens informal cliques of workmen and inclines them to subvert the authority of management; or it may foster the formation of a labor union or excite activity on the part of an existing one. Both these social consequences may then themselves “feed back” and influence the level of wages.

Economic sociology. The relations between economic and other social variables may be studied at three levels. At the most concrete level, the economic sociologist applies the standard tools of sociology to the study of roles and organizations that specialize in economic activities. He may, for example, study the sources of recruitment, career patterns, life styles, and role strains of skilled workers in an industrial firm; or he may study the organization of the firm itself, analyzing the status systems, power and authority relations, patterns of deviance, cliques and coalitions, and the relations among these phenomena.

At the second level, the economic sociologist analyzes the relations between economic structures and other structures. The work of Max Weber, especially, exemplifies this level of analysis. In particular, Weber was preoccupied with the conditions under which industrial capitalism of the modern Western type could arise and flourish. Initially, he was careful to distinguish between industrial capitalism and other forms, such as finance capitalism and colonial capitalism; industrial capitalism refers to the systematic and rational organization of production itself. Having identified industrial capitalism, Weber sought to identify the historical conditions most conducive to its rise and continuing existence. One of his most famous arguments is that the rise of ascetic Protestantism, especially Calvinism, established social and psychological conditions conducive to this particular form of capitalism (1904–1905). Another well-known argument developed by Weber is that bureaucracy provides the most rational form of social organization for perpetuating industrial capitalism (1922). He also found in the political-legal complex, especially in property laws and monetary systems, many other institutional structures conducive to industrial capitalism.

Weber never developed his economic sociology into a full theoretical system. Rather, he remained at the level of generating historical insights about the pattern of institutional structures surrounding important economic phenomena. Even so, it is possible to see his distinctive contribution to economic sociology. Unlike traditional economists, Weber was not interested in the regularities produced within the capitalist system of production (regularities such as the business cycle); instead, he was interested in establishing the important institutional conditions under which capitalist systems —and their regularities—came into being.

At the third, most abstract, level the economic sociologist considers the economic and other types of social variables as organized into analytic systems, which cut across concrete social structures, and he studies the relations among these systems. This approach is exemplified in the works of Talcott Parsons and Neil J. Smelser (see Parsons 1937; Parsons & Smelser 1956; Smelser 1963). The economic system, for example, consists of suppliers of factors of production, producers, and consumers, none of which should be identified with any particular social structure but all of which can be viewed, at this abstract level, as interacting with one another in a network of markets. Furthermore, the economic system interacts with other social systems. For example, the economy provides wage payments and consumer goods and services in exchange for the motivation and skills, so necessary for a viable labor force, that are generated by the “pattern-maintenance” social system, which includes familial, educational, and specialized-training structures.

By culture is meant that complex of existential and evaluational symbols which provide meaning and legitimacy to the conduct of social life. Concrete cultural items are cosmologies, values, ideologies, aesthetic productions, and scientific knowledge. The economic sociologist is concerned with the ways in which these symbols facilitate or inhibit various types of economic activity and the ways in which economic behavior leads to modifications of cultural symbols.

Little research has been conducted on the role of cultural factors within economic organizations. What has been done focuses mainly on problems of effective communication. One of the persistent problems of bureaucracies, for example, is the disruption that occurs when necessary information is altogether lacking, withheld, distorted in passage, or too slow in arriving. Numerous studies of industrial bureaucracy have uncovered typical points of distortion and omission: subordinates “cover up” information they do not wish their superiors to know, and foremen “soften” orders from above out of sympathy with workmen. [SeeOrganizations, article onorganizational intelligence.]

Stimulated mainly by the Marxian and Weberian traditions, sociologists have conducted a more substantial amount of research on the relations between economic organization and cultural symbols. Some research, such as that of Robert N. Bellah on Tokugawa Japan (1957), focuses directly on Weber’s problem concerning the ways in which religious beliefs stimulate or inhibit economic development. Other scholars have inquired into the relations between ideologies and economic activity. The most thorough study of ideologies as instruments of social control in industry is the comparative research of Reinhard Bendix (1956) on managerial ideologies as they have developed in four industrializing countries—Great Britain, the United States, Russia, and East Germany. Bendix’s main concern is with the justifications that managerial classes have generated in the process of inducing workers to submit to their authority. The effects of ideology in relieving role-strains are emphasized in a study of the American business creed by Francis Sutton and his associates (1956). These investigators attribute the tenacity of the free-enterprise ideology among businessmen to strains in their roles: for example, their own ambivalence toward the phenomenon of bigness in the American economy is smoothed over by a defiant reassertion of the values of traditional free enterprise. Ely Chinoy’s study of automobile workers (1955) also stresses the frustration-reducing elements of ideology, which often serves to rationalize the discrepancies between the expectations generated by the “American dream” of equality of opportunity and the actual life situations of the workers.

Solidary groupings include families, friendship groups, and diffuse collectivities, such as neighborhood, racial, and ethnic groupings. Solidary groupings, which occupy an important place in the integrative system of society, are typically characterized by face-to-face interaction and close personal understandings and loyalties among members. The economic sociologist asks how these groupings influence, and are influenced by, economic behavior.

Industrial sociology

Recognition of the importance of solidary groupings within industrial organizations is closely associated with the rise of the “human-relations” approach in industrial sociology during the interwar period. Before the rise of this school, industrial sociology in the United States was mainly under the influence of the “scientific-management” approach associated with the name of Frederick W. Taylor. According to this approach, workers in industrial organizations can be treated primarily as isolated neurophysiological organisms with definite capacities and skills; their efficiency, moreover, is largely a product of such factors as speed of work, amount of effort expended, and amount of rest allowed for recovery of strength. The scientific-management school more or less ignored the social-psychological determinants of morale and efficiency.

In the mid-1920s, when the famous Hawthorne experiments on productivity began in the Western Electric Company in Chicago, the initial emphasis was on the effects of various nonsocial factors (lighting and rest periods, for example) on worker performance. During the course of the experiments, however, it became apparent to the investigators that these “physical” factors were not nearly so important in fostering high morale and productivity as various “human” factors, such as receiving status, being accepted in a meaningful primary group, and being allowed to express grievances to a patient and responsive authority. The investigators, in short, isolated the solidary grouping as a determinant of economic behavior (see Roethlisberger & Dickson 1939). Further experiments conducted in the Bank Wiring Room revealed that cliques of workmen could also affect productivity adversely by setting and enforcing their own informal standards of production rates, which were different from those established by management. These kinds of findings have given rise to a whole tradition of research on the diverse relations between the formal and informal organizations within a bureaucracy and on how these relations affect organizational functioning. [SeeOrganizations, article Ontheories of organizations.]

Family structure

Most research on the relations between economic organization and solidary groupings concerns the ways in which certain kinds of family structure may facilitate or inhibit economic activity. For example, primogeniture may facilitate the formation of an urban-industrial labor force, since this type of inheritance system ejects younger sons from the land and makes them possible candidates for other lines of employment; thus, research by Conrad M. Arensberg and Solon T. Kimball (1940) found that younger sons constituted many of the migrants in rural Ireland. On the other hand, certain types of family life may inhibit economic activity. David Landes (1951) has argued that the peculiar structure of the French business family has kept the typical firm small and has thus inhibited economic growth. In his study of the Chinese family (1949), Marion J. Levy isolated the factors of particularism, favoritism, and functional diffuseness as features of classical Chinese kinship that tended to inhibit industrialization.

With respect to the influence of urban-industrial life on the family, most research in the interwar period—for example, the work of Ernest W. Burgess and Harvey J. Locke (see Burgess et al. 1945) —was based on the assumption that urbanization and industrialization lead to the isolation and disintegration of the family. More recent research has challenged or modified this thesis. Talcott Parsons has argued that the urban-industrial complex does not cause the family to deteriorate but rather gives rise to a more highly specialized, and in some ways more effective, family system (Parsons et al. 1955). In a massively documented study, William J. Goode (1963) has attempted to demonstrate and explain the fact that the conjugal nuclear family is the more-or-less universal concomitant of modernization.

Studies of consumption

In one respect the economists’ traditional concern with personal consumption reflects a preoccupation with the relations between solidary groupings and the economy, since this type of consumption commonly refers to the demands made by the household sector on the production sector. Throughout most of the history of economic thought, scholars have postulated some rather simple psychological principles that are assumed to govern consumers’ behavior—principles such as the hedonistic calculus, diminishing marginal utility, or indifference-curve maps. Manifestly, however, as the work of Thorstein Veblen has so well demonstrated, social position and attitudes directly affect tastes and, by implication, make for variation in individual and aggregate consumption functions (Veblen 1899). In recent decades economists and sociologists have attempted to mobilize a number of social and psychological variables to explain differential consumption and saving patterns. James Duesenberry, for example, formally incorporates a principle of imitative spending into his theory of consumer behavior (1949). Milton Friedman posits age and composition of family as determinants of tastes, which in turn affect the consumption function (1957). George Katona, using the survey method, has undertaken to study consumer attitudes extensively and to predict consumer behavior from these attitudes (1951; 1960). Finally, sociologists and economists have produced a plethora of empirical studies showing how social-structural variables such as age, stage in family cycle, race, home-ownership status, and degree of urbanization determine spending and saving patterns. On the whole, these efforts have not produced a formally adequate theory of consumption that systematically incorporates social-structural variables. The closest approximation to such a theory is found in the work of Guy H. Orcutt and his associates (1961), who have introduced variables such as marital status and duration of marriage, as well as age, education, and race of head of household, into probability models of spending and saving behavior.

From at least the time of Adam Smith, who paid particular attention to the division of labor as a determinant of the wealth of a nation, economists have recognized the importance of role differentiation in economic life. By and large, however, their concern has been restricted to the relations between the specialization of labor and economic variables, such as productivity, wage differentials, the distribution of the shares of income, and selected aspects of labor—management relations. Sociologists have introduced more and different kinds of variables into the analysis of occupations and, in particular, have focused explicitly on the organization of differentiated roles into stratified systems.

Economists’ versions of the attitudes and behavior of individuals in occupational roles generally follow the logic of supply and demand. They assume that the amount of work a person offers in the market is some function of the economic rewards available to him. While a number of different labor-supply functions have been advanced, most of these ignore the effects on the worker of social factors other than economic incentives. By contrast, sociologists conceive of roles (including occupational roles) as organized clusters of activities involving interaction with the physical, social, and cultural environments. These activities are structured and regulated by values, norms, and sanctions. Economic rewards and deprivations are important, but they constitute only one of several types of sanctions. Roles, furthermore, are subject to a number of types of strains, reactions to which influence the incumbent’s attitudes and behavior. In analyzing the foreman’s role in industry, for example, sociologists have discovered that his role is subject to considerable strains because it has been emasculated in past decades in two important ways: first, centralized management of control has made him less an independent authority over production and more an implementor of ready-made decisions; second, the centralization of the handling of grievances in the unions has relieved him of certain “human-relations” functions. The foreman, caught in a role that is simultaneously limited in function and beset by cross-pressures, often wavers between identification with management, with workers, and with other foremen (Leiter 1948). Contemporary sociological research has yielded similar types of descriptions and analyses of behavior in executive, professional, worker, and miscellaneous service roles.

Above and beyond wage conditions and level of prosperity, which are perhaps the most important determinants, economists and sociologists have un-covered a number of variables that influence labor turnover and absenteeism (for example, see Parnes 1954). Social factors influencing turnover are occupation (the average turnover of teachers, for instance, is much lower than that of factory workers); age (older workers tend to change jobs less often than younger workers); sex (women move in and out of the labor force more than men but probably do not move geographically and occupationally so much); and race (Negro men tend to change jobs more often than white men). Some of the conditions that affect absenteeism, besides wages, are distance of residence from plant; size of firm (which is undoubtedly related to morale); occurrence of holidays (absenteeism drops just before holidays); age (young men display absenteeism more than old); marital status (single men are absent more than married men); and arduousness of work (which encourages absenteeism). [SeeLabor Force, article onmarkets and mobility.]

Stratification systems

Much of the sociological research on role differentiation within economic organizations has concerned the relations between formal and informal organization (reviewed above). In addition, sociologists have studied status systems of industrial organizations and their relations to behavior. As a general rule, status in an organization is determined by the degree of skill, the level of authority and responsibility, and the level of remuneration of an occupational position. however, additional criteria that are imported from “outside” the workplace, such as age, sex, and racial or ethnic background, affect the status of the individual in the organization.

Because of the multiplicity of determinants of general status, individuals in organizations frequently experience a sense of ambiguity as to their actual status (Homans 1953). This leads to a focus on the symbolic aspects of status, such as the number of telephones or amount of floor space per office. Many conflicts in organizations revolve around the distribution of symbols rather than the distribution of the determinants of status underlying these symbols. Another characteristic of industrial organizations that arises from the multiplicity of determinants of status is the tendency toward “status crystallization”—that is, bringing all aspects of status roughly into line with one another. If an individual is paid much for performing a low-skill job, for example, dissatisfactions both for him and his fellow workers, as well as pressures to balance wage and skill levels, arise. This tendency for all aspects of status to be brought into line underlies many conflicts in industrial settings: for example, opposition to promoting a young executive too rapidly for his age and experience, to placing women in positions of authority, and to elevating Negroes to high-level jobs.

With respect to the relations between economic systems and stratification systems, two strands of research dominate the contemporary scene. The first, stemming from the Marxian tradition, concerns the degree to which specific types of economic systems appear to give rise to distinctive types of stratification systems. Alex Inkeles and Peter Rossi (1956), for instance, found that in a number of industrialized nations, occupations associated with industrial production (engineer, foreman, machine worker, etc.) were assigned very similar positions in the general prestige hierarchy of occupations. The second strand of research, stemming perhaps from an ideological preoccupation with equality of opportunity, concerns the degree to which rates of upward social mobility increase or decrease in industrial society. Basing their case on extensive comparative data, Seymour M. Lipset and Reinhard Bendix (1959) argued that rates of social mobility are very similar in all the industrial societies of the West and that these similarities are traceable to common features of the occupational structures of these societies. Additional research, the most conspicuous of which is the work of Natalie Rogoff (for example, 1953), concerns the degree to which opportunities for upward mobility are “closing” under conditions of advanced industrial development in the United States.

The term “political” here refers to the creation, institutionalization, and utilization of power in a social setting. Defined this broadly, the term encompasses the study of authority systems in organizations, the study of governments, and the study of competition and conflict among groups. The economic sociologist is concerned with studying the mutual relations between economic activities and these diverse political phenomena.

Most studies of authority systems within industrial firms involve the relations between the types of supervision (typically described in terms of an authoritarian-democratic dimension) and worker morale, productivity, and receptivity to innovations. The most common finding is that worker morale and productivity are higher under “employee-centered” leadership than under leadership oriented to technical standards of efficiency (Viteles 1953). Most of the experiments and field studies on supervision have been carried out in countries with democratic traditions, especially the United States and Great Britain; obviously, studies of societies with different political traditions might show different results.

Research on the political relations between economic organizations and other social units has advanced on a variety of fronts. Under the heading of “the economics of imperfect competition,” economists have studied a variety of political involvements of business firms: ways in which large firms are able to control, and perhaps dominate, prices and output under monopolistic conditions; ways in which wealth and power become concentrated in the economy; and ways in which government policies (e.g., antitrust policies) influence the structure and behavior of firms (for example, Mason 1959). Economists and sociologists have devoted a modest amount of research to the power relations between stockholders and managers and between consumers and business firms, but far more research has been done on the power relations and conflicts between business firms and labor unions. In particular, scholars have devoted much study to the causes of labor disputes (see Korn-hauser et al. 1954; Knowles 1952). Some causes have been fairly well established: strikes occur more frequently under conditions of prosperity, more frequently in isolated industries with homogeneous worker populations, and less frequently under totalitarian governments and in periods of national crisis.

Finally, much contemporary research and discussion focuses on the relations between business and government. This research is shrouded in ideological controversy and confused findings. One school of thought, advanced by the late C. Wright Mills (1956), argues that national political power in the United States has become increasingly concentrated in recent decades and that the holders of power and makers of important decisions are a small group of corporate executives and military officials; this view, however, has been challenged on both methodological and substantive grounds. The empirical research on economic controls over local politics also shows a mixed picture. For example, in a study of a Southern community, Floyd Hunter (1953) concluded that the major decisions were guided by a small group of economically dominant individuals. Other research—for example, that of Delbert Miller (1958) and Robert Schulze (1958)—indicates that the degree to which business groups dominate local politics varies considerably from community to community and over time.

Landes, David M. 1951 French Business and the Businessman: A Social and Cultural Analysis. Pages 334–353 in E. M. Earle (editor), Modern France: Problems of the Third and Fourth Republics. Princeton Univ. Press.

Leiter, Robert David 1948 The Foreman in Industrial Relations. New York: Columbia Univ. Press.

Roethlisberger, Fritz J.; and Dickson, William J. (1939) 1961 Management and the Worker: An Account of a Research Program Conducted by the Western Electric Company, Hawthorne Works, Chicago. Cambridge, Mass.: Harvard Univ. Press. → A paper-back edition was published in 1964 by Wiley.

Weber, Max (1904–1905) 1930 The Protestant Ethic and the Spirit of Capitalism. Translated by Talcott Parsons, with a foreword by R. H. Tawney. London: Allen & Unwin; New York: Scribner. → First published in German. The 1930 edition has been reprinted frequently.

Weber, Max (1922) 1957 The Theory of Social and Economic Organization. Edited by Talcott Parsons. Glencoe, III.: Free Press. → First published as Part 1 of Wirtschaft und Gesellschaft.

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Economics

Dictionary of American History
COPYRIGHT 2003 The Gale Group Inc.

ECONOMICS

General Characteristics

Economics studies human welfare in terms of the production, distribution, and consumption of goods and services. While there is a considerable body of ancient and medieval thought on economic questions, the discipline of political economy only took shape in the early modern period. Some prominent schools of the seventeenth and eighteenth centuries were Cameralism (Germany), Mercantilism (Britain), and Physiocracy (France). Classical political economy, launched by Adam Smith's Wealth of Nations (1776), dominated the discipline for more than one hundred years. American economics drew on all of these sources, but it did not forge its own identity until the end of the nineteenth century, and it did not attain its current global hegemony until after World War II. This was as much due to the sheer number of active economists as to the brilliance of Paul Samuelson, Milton Friedman, and Kenneth Arrow, among others. Prior to 1900, the American community of economists had largely been perceived, both from within and from abroad, as a relative backwater. The United States did not produce a theorist to rival the likes of Adam Smith (1723–1790), David Ricardo (1772–1823), or Karl Marx (1818–1883).

Several factors in American economic and intellectual history help explain this fact. First, the presence of a large slave economy before the Civil War resulted in a concentrated effort to weigh the arguments for and against free labor. The landmark study in American economic history of the last century, Robert Fogel and Stanley Engerman's Time on the Cross (1974), speaks to this unfortunate legacy. Second, the belated onset of industrialization (in 1860, 80 percent of the population was still rural), and the founding of many land-grant colleges with the Morrill Act of 1862 resulted in the emergence of a field of specialization that endures to this day: agricultural or land economics. Even in the interwar years, the Bureau of Agricultural Economics was a major center of research in the field. Third, American federalism, by decentralizing the management of money and credit, had direct and arguably dire consequences for the development of banking and capital accumulation. Persistent debates on the merits of paper currency can be traced from the latter half of the eighteenth century right up to 1971, when American fiat money replaced the gold standard once and for all.

The relatively high standard of living and the massive wave of immigration during the latter part of the nineteenth century might also have played a part in the diminished role of socialist thinking. A liberal ideology coupled with the absence of an aristocracy meant that socialism never became as rooted in America as in Europe. In the few instances that it did, it tended to be of the more innocuous variety, such as Robert Owen's (1771–1858) 1825 settlement of New Harmony, Indiana, or Richard T. Ely's (1854–1943) Christian socialism. The most popular reform movement in late-nineteenth-century economics was inspired by Henry George's (1839–1897) Progress and Poverty (1879), which argued for a single tax on land. Economic theory tended then as now toward liberalism if not libertarianism, with its deeply entrenched respect for individual rights, market forces, and the diminished role of the government.

What probably most explains the form and content of American economics is its resistance to the influence of other disciplines. Because of the sheer size of the economics profession (there are some 22,000 registered members of the American Economic Association, and that by no means exhausts the number), it tends to be very inward-looking. Not since before World War II have economists eagerly borrowed from the other sciences. Even prewar economists were more likely to assimilate concepts and methods from physics and biology than from sociology or psychology. Instead, "economic imperialists" such as Gary Becker take topics that have traditionally been in other social sciences, such as voting, crime, marriage, and the family, and model them in terms of utility maximization.

The Colonial and Antebellum Period

In colonial America, most contributors to economics, such as Thomas Pownall (1722–1805), governor of Massachusetts, and Samuel Gale (1747–1826) were inspired by the British economists John Locke (1632–1704), David Hume (1711–1776), and Adam Smith. Benjamin Franklin (1706–1790) befriended both the British and French political economists of the time. Because of the shortage of American money, Franklin advocated the circulation of paper money as a stimulus to trade, and he even convinced Hume and Smith of the relative soundness of paper issue in Pennsylvania. Although Franklin wrote on the importance of the development of manufacturing for the American economy, he believed, as would Thomas Paine (1737–1809) and Thomas Jefferson (1743–1826), that the true destiny for America lay with agriculture.

The American republic called for concrete measures on money and banking, as well as policies on trade and manufacturing. In the early years of the new regime, Jefferson and Alexander Hamilton (1757–1804) loomed large as forgers of economic ideas and policy. Jefferson was a friend of Pierre Samuel du Pont de Nemours (1739–1817), Destutt de Tracy (1754–1836), and Jean-Baptiste Say (1767–1832), and he supervised the translation of Tracy's Treatise on Political Economy (1817). In a series of tracts, he argued that commerce ought to remain a handmaiden to agriculture, and he took seriously Hume's caveats about public debt. Hamilton, by contrast, advocated the growth of commerce and manufacturing. He sought means to improve the mobility of capital as a stimulus to trade, and with his National Bank Act and Report on Manufactures (1791), he went very much against Jefferson's policies.

In antebellum United States we find dozens of contributors to political economy, notably Jacob Cardozo (1786–1873), Daniel Raymond (1786–1849), Francis Way-land (1790–1865), Henry C. Carey (1793–1879), Amasa Walker (1799–1875), and Charles Dunbar (1830–1900). Many of these tailored their analyses to the American context of unlimited land and scarcity of labor. Malthusian scenarios held little sway. The two most prominent European writers in America, both adherents to Smith, were Say, whose Treatise on Political Economy was widely read and circulated after its first translation in 1821, and John Ramsey McCulloch (1789–1864). Jane Marcet's (1769–1858) Conversations on Political Economy (1816) sold in the thousands, thereby disseminating some of the more central principles of British and French political economy to the inquiring American. The prominent German economist of the period, Friedrich List (1789–1846), first made his name while living in the United States; his Outlines of American Political Economy (1827) helped sustain the enthusiasm for protective tariffs. Carey is usually viewed as the most original American-born thinker of the period, and the first to gain an international reputation. His three-volume Principles of Political Economy (1837) did much to challenge Ricardo's doctrine of rent, as well as propel him into a significant role as economic advisor to the government in Washington.

The Gilded Age (1870–1914)

Homegrown economic theorists became much more common in this period, spurred into controversies over banking and trade and the onset of large monopolies. The most prominent measure taken in this period, the Sherman Antitrust Act (1890), was not received enthusiastically by the more conservative economists such as Arthur Hadley (1856–1930) because it violated the central principle of laissez-faire. But others, such as Ely, saw the Act as a necessary measure.

Steps were also taken to professionalize, with the formation of the American Economics Association (1885) and the Quarterly Journal of Economics (1887). Two more journals of high quality were formed in this period, the Journal of Political Economy (1892) and the American Economic Review (1911). Economics also made its way into the universities. Before the Civil War, numerous colleges taught the subject under the more general rubric of moral philosophy, or even theology. But explicit recognition first came with the appointment of Charles Dunbar to the chair of political economy at Harvard in 1871. The prolific economist and son of Amasa, Francis A. Walker (1840–1897) gained a chair at Yale in 1872 and then served as president of MIT in the 1880s and 1890s. By 1900, hundreds of institutions were offering graduate degrees in economics, though the majority of doctorates came from a small set of universities, notably Chicago, Columbia, California, Harvard, and Johns Hopkins. The expansion of institutions of higher learning in this period served to reinforce the propensity to specialize within the field. While the economics profession mostly honors its contributors to pure theory, the majority of doctorates in American economics are and have been granted in applied fields, notably labor, land, business, and industrial economics.

In the area of theoretical economics, the names of Simon Newcomb (1835–1909), Irving Fisher (1867–1947), and John Bates Clark stand out. Newcomb was better known for his work in astronomy and coastal surveying, but his Principles of Political Economy (1886) did much to endorse the advent of mathematical methods. Fisher was without question the most renowned and brilliant of his generation of economic theorists. As a doctoral student at Yale, Fisher worked with the eminent physicist J. Willard Gibbs (1839–1903) and the social Darwinist William Graham Sumner (1840–1910). His first book, Mathematical Investigations in the Theory of Value and Prices (1892), was a significant landmark in the rise of mathematical economics, and it treated the utility calculus in terms of thermodynamics. His later efforts, The Purchasing Power of Money (1911) and The Theory of Interest (1930) became two of the most significant works of the twentieth century. The Fisher Equation is still taken to be the best rendition of the quantity theory of money, noted for its efforts to distinguish different kinds of liquidity and to measure the velocity of money.

Clark reigned at Columbia for much of his career, and he is most noted for his analysis of the concept of marginal productivity as an explanation of factor prices, wages, interest, and rent. His Philosophy of Wealth (1886) and Distribution of Wealth (1899) blended the new marginalism with sociological and ethical concerns. Clark earned international renown for his concept of marginal productivity and helped inspire the next generation of American marginalists, notably Frank Taussig (1859–1940) at Harvard, Frank Fetter (1863–1949) at Princeton, and Laurence Laughlin (1871–1933) at Chicago.

Although the contributions of Fisher and Clark were more enduring, the school that was most distinctively American from approximately 1890 to 1940 was the one known during the interwar years as Institutionalism. The most prominent founders were Ely, Veblen, Mitchell, and John R. Commons (1862–1945). Later contributors included the son of John Bates, John Maurice Clark (1884–1963), and Clarence E. Ayres (1891–1972), but there were many more foot soldiers marching to the cause. Inspired by evolutionary biology, the Institutionalists took a historical, antiformalist approach to the study of economic phenomena. Veblen's Theory of the Leisure Class (1899), the most enduring text of this group, examines consumption patterns in terms of biological traits, evolving in step with other institutions—political and pecuniary. Commons focused on labor economics and helped devise many of the measures, such as workmen's compensation, public utility regulations, and unemployment insurance, that resulted in the social security legislation of the 1930s.

Interwar years 1919–1939

American economics was invigorated by the war and benefited enormously from a wave of immigration from Europe's intellegentsia. Of the three most prominent grand theorists of the period, and arguably of the entire century, namely John Maynard Keynes (1883–1946), Joseph Schumpeter (1883–1950), and Friedrich Hayek (1899–1992), the latter two came and settled in the United States: Schumpeter to Harvard (1932–1950), and Hayek to New York (1923–1924) and later to Chicago (1950–1962). Both did most of their critical work while in Europe, but were part of a larger migration of the Austrian school of economics, notably Ludwig von Mises (1881–1973), Fritz Machlup (1902–1983), and Karl Menger (1902–1985). Other prominent immigrants from Europe were Abraham Wald (1902–1950), John Harsanyi (1920–2000), Tjalling Koopmans (1910–1985), Oskar Lange (1904–1965), Wassily Leontief (1906–1999), Jacob Marschak (1898–1977), John von Neumann (1903–1957), Oskar Morgenstern (1902–1977), Franco Modigliani, Ronald Coase, and Kenneth Boulding (1910–1993).

Notwithstanding the inestimable stimulation of foreign-trained economists, the most prominent figures of this period were American born and educated, notably Fisher, Mitchell, Frank Knight (1885–1972), Henry Ludwell Moore (1869–1958), and Edward Chamberlain (1899–1967). Chamberlain's landmark study, The Theory of Monopolistic Competition (1933), contributed to the recognition of the mixed economy of mature capitalism. Fisher's The Making of Index Numbers (1922) made important headway on the measurement of key economic indicators. Mitchell stood out as the one who blended a still vibrant community of Institutionalism with the more ascendant neoclassicism. He and Moore's studies of business cycles helped foster the growth of econometrics, resulting in the formation of the National Bureau of Economic Research (1920) and the Cowles Commission (1932), which proved to be an important spawning ground for econometrics and, more generally, mathematical economics. Some leading economists associated with the Cowles Commision are Fisher, Koopmans, Marschak, Lange, Arrow, Gérard Debreu, James Tobin (1918–2002), and Simon Kuznets (1901–1985).

Knight's Risk, Uncertainty and Profit (1921) remains a classic in the study of capital theory and the role of the entrepreneur. Together with Currie, Jacob Viner (1892–1970), and Henry Simons (1899–1946), Knight helped to push the economics department of the University of Chicago into the top rank. With the subsequent contributions of George Stigler (1911–1991), Hayek, and Friedman, Chicago became the leading voice of the status quo. Among Nobel prizewinners in economics, roughly one-half have at some point in their career been associated with the "Chicago School."

Postwar Era

Here we see the clear ascendancy of mathematical economics as the dominant professional orientation. Economists shifted away from the literary pursuit of laws and general principles that characterized nineteenth-century political economy, in favor of models and econometric tests disseminated in the periodical literature. The number of U.S. journals began to surge in the postwar years to 300 by the year 2002, and the number of articles has grown almost exponentially.

No one stands out more prominently in the 1950s to 1960s than Paul Samuelson, not least because of his best selling textbook, Principles of Economics (1948). His precocity for mathematics resulted in a series of papers, which were immediately acclaimed for their brilliance. Published as The Foundations of Economic Analysis (1947), Samuelson's opus contributed to almost every branch of microeconomics. He devised a solution to the longstanding problem of price dynamics and formulated the axiom of revealed preference, which stands at the very core of neoclassical theory.

Other major contributors to mathematical economics, starting from the interwar period, were Wald on decision theory, Koopmans on linear programming, Leontief on input-output analysis, L. J. Savage (1917–1971) on mathematical statistics, and Harold Hotelling (1895–1973) and Henry Schultz (1893–1938) on demand theory. Arrow and Debreu, who moved to the States in 1949, devised through a series of papers in the 1950s an axiomatic rendition of the general theory of equilibrium—the doctrine by which prices bring about market clearance. In many respects, this put a capstone on the neoclassical theory that had commenced in the 1870s.

Arrow also made significant contributions to welfare economics with his Social Choice and Individual Values (1951). His book targeted the role of strategizing in economics, an idea that was of parallel importance to game theory.

The landmark works in the field of game theory came out of Princeton during and immediately after the war—namely, von Neumann and Morgenstern's Theory of Games and Economic Behavior (1944) and two seminal papers by the mathematician John Nash (1950, 1952). Strategic thinking also fostered the pursuit of Operations Research at the RAND Corporation in Santa Monica (founded in 1946). The World War II and the Cold War had much to do with the funding of these new fields, with Thomas Schelling's Strategey of Conflict (1960) as one of the best-known results. Related investigations are Rational Choice Theory, associated most closely with James Buchanan, and experimental economics, launched by Vernon Smith and Charles Plott. Herbert Simon's (1916–2001) concept of satisficing has also linked up with the emphasis in Game Theory on suboptimal behavior. In a nutshell, neither utility nor social welfare are maximized because information and cooperation prove to be too costly.

Keynes had traveled to the United States during and after World War II both to advise the American government and to help launch the International Monetary Fund that came out of the famous Bretton Woods gathering of 1944. Keynes's General Theory of Employment, Interest, and Money (1936) is widely viewed to this day as the single most influential book of the last century, and his ideas were widely disseminated by Alvin Hansen (1887–1975), Lauchlin Currie (1902–1993), Lawrence R. Klein, Tobin, Galbraith, and Samuelson. Nevertheless, Keynesianism was superceded in the 1950s by Friedman's monetarism—and then in the 1970s by the New Classicism of John Muth, Neil Wallace, Thomas Sargent, and Robert Lucas. McCarthyism may have also reinforced this shift since it became expedient for survival to avoid any controversial political issues that might stem from economic analysis. While Keynes was not a socialist, his inclinations toward a planned economy and his skepticism about market forces were seen as suspect.

Two other areas of specialization to which Americans made considerable postwar contributions are consumption theory and economic development. Of the first field, the names of Samuelson, Friedman, Modigliani, Hyman Minsky (1919–1997), James Duesenberry, and William Vickery (1914–1996) belong in the front rank. Of the second field, Kuznets, W. Arthur Lewis (the first major African American economist, originally from St. Lucia), Theodore W. Shultz (1902–1998), Robert Solow, and Albert O. Hirschman are noteworthy. Almost all of these men garnered the Alfred Nobel Memorial Prize in Economic Science, which commenced in 1969.

Until the latter part of the twentieth century, women had been grossly under-represented in American economics, but from those decades forward they have included roughly 25 percent of the profession. More women entered the profession in the interwar years, so that by 1920, 19 percent of Ph.D.'s went to women, though this figure dropped dramatically after World War II. Three who made important insights in consumption theory during the 1940s were Dorothy Brady (1903–1977), Margaret Reid (1895–1991), and Rose Friedman. Both Rose Friedman and Anna J. Schwartz have coauthored major works with the more famous Milton Friedman, making them the most widely read of contemporary American women economists. Many of the economists listed in this article advised the government—particularly on money, banking, and trade. Significant guidance from economists was widely acknowledged during the Great Depression with Franklin Roosevelt's New Deal. But it was in the postwar period that economists were extensively instituted into the government rather than brought in on an ad hoc basis. The Council of Economic Advisors, established in 1946, oversaw the fiscal reforms of the Kennedy era and took credit for the subsequent economic growth. The American government is replete with committees forging economic policy on virtually every applied field in the discipline. The chairman of the Federal Reserve Board, founded in 1914, is often taken from academic ranks and now stands out as the most powerful player in the American economy. Keynes once remarked of economists that "the world is ruled by little else." For better or for worse, the power that economists now hold in the American government epitomizes the triumph of the economics profession and the widespread view that the economy—and hence human well-being—is within our control.

BIBLIOGRAPHY

Allen, William R. "Economics, Economists, and Economic Policy: Modern American Experiences." History of Political Economy 9, no. 1 (1977): 48–88.

Barber, William J. From New Era to New Deal: Herbert Hoover, the Economists, and American Economic Policy, 1921–1933. New York: Cambridge University Press, 1985.

Barber, William J., ed. Breaking the Academic Mould: Economists and American Higher Learning in the Nineteenth Century. Middletown: Wesleyan University Press, 1988.

Carver, Earlene, and Axel Leijonhufvud. "Economics in America: the Continental Influence." History of Political Economy 19, no. 2 (1987): 173–182.

Coats, A.W. On the History of Economic Thought: British and American Economic Essays. Volume 1. London and New York: Routledge, 1992.

Economics

The theory of the division of labor is at least two and a half millennia old. The practice of the division of labor undoubtedly has a much longer history. Both the theory and the practice stress that joint activity is more productive compared with individual or isolated activity, and both apply to different spheres of work: work within a factory or group and work among firms (e.g., between factories). The division of labor is therefore a principal mode of coordination for all such disparate but connected activity.

The theory of the division of labor has different facets to it, in that it applies to both physical labor and intellectual labor. As an object of study and a tool of analysis, it is at the foundation of substantially all of economics. Moreover, the practice of economics itself makes use of, and thus reflects, the division of labor. This, perhaps more than any other factor, explains the importance of economics.

The combination of human psychology and the division of labor also help explain two major features of human behavior: selective perception and status emulation. Each of the major skill groups (or crafts or trades) that work more or less together to produce a pin, a truck, or a house tends to think that its contribution is the most valuable. Individuals acquire their status based on how they perform in their own domain of work, and they seek to emulate those already successful in that domain. The same is true in economics insofar as it too is erected upon the principle of the division of labor. It is no accident that the division of labor, selective perception, and status emulation were also among the major themes of Adam Smith’s Wealth of Nations (1776).

The division of labor within economics takes place along a number of axes, with their respective spheres interacting in a recursive manner. The existence of a multiplicity of practices on each axis is due both to the multifaceted nature of the economy and its study (economics) and to the different positions or standpoints that economists can take. Each such standpoint, and its correlative body of practice, is accompanied by selective perception and status emulation, for the practitioner of each type laud its attributes and pursues success defined in its terms.

One axis is that of the criteria by which economists produce knowledge. One of these criteria is deduction, which, when correctly practiced, produces conclusions that are valid, given the premises and the system of logic, but necessarily true. Another is induction, which produces conclusions that may or may not be true, depending on the entirety of practice. This is the field of epistemology, or methodology, which is also practiced along twin axes in another respect. Given the variety of credentials that a proposition may have, two uses of those credentials may be made: The prescriptive use postulates that one and only one set of credentials produces acceptable knowledge, while the credentialist use affirms that every proposition has its own set of credentials and that the individual is free to accept or reject it. These modes of use tend to be at the heart of competing practices, each yielding status emulation.

A second axis has to do with the fundamental substantive paradigms that tend to govern all work in economics. This axis constitutes the ontology of economics. Among the different paradigmatic possibilities are the fundamental theories of a surplus; constrained maximization (maximization subject to constraints, such as cost or legal prohibitions or requirements); productivity or exploitation; culture; and the attainment of a level of welfare and the structure of its distribution. Paradigms are among the most important elements in the social construction of economics.

A third axis concerns the fundamental problem of economics. Among the multiplicity of contenders for this designation are: the organization and control of the economic system, the efficient (or optimum) allocation of resources, economic growth, maximization of welfare, distribution of income (and wealth), and the ordinary business of life in terms of earning a living.

A fourth axis, somewhat related to the third, concerns the organization and control of the economic system itself. A central focus here is the institution of private property, while institutions such as the market, the development of the division of labor itself, and the system of social control are also relevant. One composite approach is that of the “market plus framework,” in which markets exist on the basis of the framework of social controls. The identity of the framework tends to be reduced to legal and moral rules, inclusive of custom, education, religion, and various forms or sources of law. In this model, markets are not given, they are socially constructed by the interactions of the institutions that form and operate through them. At the very least, markets—and indeed the economic system itself—depend upon the legal foundations of those in control of the state (or those who create the laws of property, contract, tort, etc.) and the strategic behavior of firms and other economic agents.

The conventional assumptions of economic theory, in its static form, have tended to include (1) perfect competition and perfect knowledge (and therefore perfect foresight); (2) given and unchanging technology, resources, tastes, population, and structure of rights; and (3) individual agents that operate independent of each other, that are mobile, and that calculate rationally in order to maximize the satisfaction (or utility) derivable from their real incomes. One or more of these assumptions can be modified, thereby engendering an array of further possibilities, such as a variety of noncompetitive conditions, imperfect information, asymmetrical information, interdependent tastes, changes in the distribution and content of rights, behavior that is less than maximizing, and changes in technology, resources, tastes, and population. Such modifications may or may not add realism, but they do tend to introduce dynamic elements.

The conduct of economics, like that of any intellectual discipline, inevitably involves some type of abstraction, such as the reduction of the number of variables in a model down to the ones deemed most important. This makes the enterprise more manageable. That being the case, economics involves both the study of actual economies and the analysis of conceptual, abstract economies. Closely related is the research protocol stipulating epistemological credentials. At one end of a spectrum is the capacity to produce unique determinate optimal equilibrium results; at the other, to produce an array of possibilities at the conditions governing their realization.

The history of economics is very much a story of schools of thought. There have been multiple schools of thought, together constituting a heterogeneous discipline, and each school has itself been heterogeneous. This heterogeneity is the result of a combination of a multifaceted economy and different positions or standpoints from which the economy can be studied. There is nothing about the economy or the training of economists that requires that one and only one variable, point of entry, or perspective be used. Accordingly, in every period in the history of the field there has been more than one school of economic thought. A particular school may endeavor to cover the entirety of economics, or it may examine only one or more parts thereof. Economics as a whole is itself further heterogeneous, and because each school typically can be formulated differently, each school is itself heterogeneous. All of this comes under the heading of “theoretical pluralism,” which differs from the ontological or paradigmatic pluralism and the epistemological or methodological pluralism described above. And all of these approaches can be rendered further complex and heterogenous by introducing normative premises of one kind or another, such as accepting existing institutions or the status quo distributions of income and wealth.

Theoretical pluralism also takes another form. Every topic in economics is characterized by particular theories. Consider the following: competition, equilibrium, business cycles, income distribution, consumption, supply of money, commodity demand, capital, investment, the entrepreneur, optimization, money, interest rates, imperialism, economic growth, supply of labor, technology, externalities, incidence of taxation, the origin of the division of labor, and the economic role of government. Each has multiple theories, even multiple groups of theories, that attempt to describe or explain the object of their respective author’s attention.

Several questions come to mind when considering why a school of economic thought arises and flowers. The rise of marginal utility economics in the 1870s is a suggestive case in point. “Marginal utility” is the change in utility associated with a change in consumption level. The term also refers to a utilitarian-calculus approach to economic analysis and decision-making. “Classical economics” refers to a group of economic thinkers who wrote after Adam Smith. The school commences with Thomas Robert Malthus, and David Ricardo and also consists of John R. McCoulloch, William Nassau Senior, and James Bill. The approach was largely finished with the work of John Stuart Mill and John Elliott Cairnes.

Among the factors that explain its existence are the following: (1) the deficiencies of classical economics, including its neglect of psychological valuation as an important demand-side aspect of value theory, its focus on economic classes and labor theory (including cost-of-production theory), and its perceived weaknesses as a defense of capitalism; (2) the logical continuation of earlier writings on utility analysis; (3) the growth of static and positivistic theory (laws of the coexistence of variables) challenging Hegelian and other historical theory (the laws of the succession of variables)—or of the study of being rather than becoming; (4) a reaction to Marxism’s emphasis on exploitation and the transient character of capitalism as part of an attack on socialist theory in general; and (5) the emergence of academic economics and its tendency to deal with trivia unsuitable for reformers. Academic economics included the use of mathematics, which was attractive insofar as it enabled economics to resemble physics, and because it effectuated a reduction of variables to the neoclassical model of demand and supply.

Among these varied explanations for the rise of the marginal utility approach, one finds ironic incongruities, such as positivism’s emphasis on the objective analysis of confirmable materials rather than metaphysical, unconfirmable general theories of history, and the marginal utility school’s criticism that classicism’s broad conclusions were based on a small structure of knowledge wrapped up in a few theorems. Both of these positions were in conflict with key features of the marginal utility school’s subjectivism.

There has also been a more or less amorphous mainstream of economics, yielding a combination of schools, some more or less orthodox and others more or less heterodox. The mainstream has run from the classical economics of Adam Smith (1723–1790), David Ricardo (1772–1823) and Thomas Robert Malthus (1766–1834), through the early versions of neoclassical economics formulated by Carl Menger (1840–1921) and Alfred Marshall (1842–1924), to the modern formulation by a group led by Paul A. Samuelson (b. 1915). Differences within each school (and between schools) arose along the different axes identified above. These differences were often identified in terms of a school’s central problem or focus. The mainstream changed from a grand macroeconomic story of production, growth, and distribution to an equally imposing story of subjectively acting individual economic units and their interaction in markets, along with the resultant allocation of resources. Under the name of “neoclassical economics,” the mainstream developed a variety of technical identifications of its central problem, many of them mutually reinforcing, such as the mechanics of utility, the operation of the price system, the working of the free enterprise system, the operation of pure markets, the mechanics of the pure theory of choice, constrained maximization decision making, the allocation of resources, and the mechanics of welfare. Schools of economic thought have tended to define themselves in terms of a central problem; the two most common have been explaining how people make their living and explaining how the economy is organized and controlled. Because the assumptions that characterized the core of mainstream neoclassicism could be changed, a further variety of sub-schools emerged within general neoclassicism. Varieties of theories of noncompetitive conditions, uncertainty, changing tastes, rights, institutions, ideology, technology, and population developed, each offering a more or less distinctively different picture of the economy.

Among the alternatives to the mainstream has been “institutional economics.” The central problem here is literally the organization and control of the economy, though with several different foci. One focus was the legal foundations of the economic system; another was the system of cultural beliefs by which people organized and instituted their economic relations, and with which they explained those relations to themselves. Common to both foci was power. The key figures of institutional economics have been Thorstein Veblen (1857–1929), Walton Hamilton (1881–1958), John R. Commons (1862–1945), and John Kenneth Galbraith (1908–2006).

In the middle third of the twentieth century, nurtured in part by reactions to the Great Depression, the focus of macroeconomics changed from growth in classical terms and the allocation of resources to the determination of the level of income. The key figure of the new macroeconomics was John Maynard Keynes (1883–1946), who argued that classical doctrines to the contrary notwithstanding, the level of income, resulting from factors governing the level of aggregate spending, was not necessarily at the full employment level. This was important not just because variations in spending were involved in the business cycle and in unemployment, but also because so many people depended on employment for their livelihood. In time, Samuelson combined neoclassical microeconomic price and resource-allocation theory with Keynesian macroeconomic income-determination theory to produce the “neoclassical synthesis.”

Thus, in combination with the further differentiating sources outlined above, one could practice economics in numerous different ways. Indeed, it could be argued that neoclassicism, or the neoclassical synthesis, was no longer the undifferentiated hegemon atop the mainstream, and today there are countless variations and combinations of treatments of topics that make up economics. This is true of all of the numerous topics that have had different but useful approaches formulated for them. Macroeconomics, for example, has had a variety of interpretations of what Keynes said and what he intended to say, plus a variety of post-Keynesian theories, not to mention new classical, real, new Keynesian, and other business-cycle theories. Microeconomics has a variety of treatments of how prices and resource allocation are determined; macroeconomics has a variety of treatments of the causes of instability; and both have in common a variety of treatments of uncertainty.

The foregoing does not exhaust the variety of ways in which economists do economics. Some economists study the performance of economic agents as if the agents were engaged in some type of cooperative or noncooperative game. That form of economics was instrumental in developing the strategy of mutual assured destruction (MAD) by the United States and the Soviet Union during the cold war, a strategy which worked to prevent World War III despite its seeming barbarous quality, mainly because the two sides thought more alike than not. Economists who do game theory are among the hordes who practice mathematical economics, a research language and mode of analysis that has been increasingly dominant since the 1960s. Other economists (and psychologists working on economic problems), have enriched the meaning of “rationality” and its attendant motivational attributes. Much of the work of economists is devoted to the description, explanation, and interpretation of what the economy is all about—as should be evident from what has been written above. Many economists self-consciously work at constructing or applying the normative, subjective, and ideological justification for market economies; many others work at its critique. Indeed, it has been said that much of the history of economics has been driven by attempts to influence the distributions of income, wealth, and opportunity in society, as well as by the control and use of government as a political means to economic ends. Which brings this discussion to such combined fields as economic sociology, law and economics, economic anthropology, economic psychology, economic history, and the history of economic thought—fields that are rich in and of themselves.

Economics

Encyclopedia of Management
COPYRIGHT 2009 Gale

Economics

The study of economics leads to the formulation of the principles upon which the economy is based. History, politics, and the social sciences cannot be understood without the basic understanding of economic principles. The science of economics is concerned with the scientific laws that relate to business administration, and attempts to formulate the principles that relate to the satisfaction of wants.

The term “economics” covers such a broad range of meaning that any brief definition is likely to leave out some important aspect of the subject. It is a social science concerned with the study of economies and the relationships between them. Economics is the study of how people and society choose to employ scarce productive resources, which could have alternative uses, to produce various commodities and distribute them for consumption. Economics generally studies problems from society's point of view rather than from the individual's. Finally, economics studies the allocation of scarce resources among competing ends.

OBJECTIVES

As a science, economics must first develop an understanding of the processes by which human desires are fulfilled. Second, economics must show how causes that affect production and consumption lead to various results. Furthermore, it must draw conclusions that will serve to guide those who conduct and, in part, control economic activity.

MICRO AND MACRO VIEWS OF THE ECONOMY

While there are numerous specialties within the academic field, at its most basic level economics is commonly divided into two broad areas of focus: microeconomics and macroeconomics. Microeconomics is the study of smaller levels of the economy, such as how an individual firm or a small group of firms operate. Macroeconomics is the study of whole economies or large sectors of economies.

Microeconomics . Microeconomics is the social science dealing in the satisfaction of human wants using limited resources. It focuses on individual units that make up the whole of the economy. It examines how households and businesses behave as individual units, not as parts of a larger whole. For instance, microeconomics studies how a household spends its money. It also studies the way in which a business determines how much of a product to produce, how to make the best use of production factors, and what pricing strategy to use. Microeconomics also studies how individual markets and industries are organized, what patterns of competition they follow, and how these patterns affect economic efficiency and welfare.

Macroeconomics. Macroeconomics studies an economy at the aggregate level. It is concerned with the workings of the whole economy or large sectors of it. These sectors include government, business, and households. Macroeconomics deals with such issues as national economic output and growth, unemployment, recession, inflation, foreign trade, and monetary and fiscal policy.

For example, many political leaders in the United States believed that economic stimulus packages (sending Americans tax rebates) from the U.S. government in 2001 and again in 2008 would spur on the national economy when the Americans spent their rebates. Economists generally agree that the economy gets a boost; however, they argue that the full impact is less than the total value of the stimulus package because people may opt to save their checks or invest in imported goods. These rebates, economists say, create temporary changes to the economy. Instead, politicians should focus on developing policies that promote healthy, long-term growth.

BASIC ECONOMIC PRINCIPLES

Basic economic principles include the law of demand, demand determinants, the law of supply, supply determinants, market equilibrium, factors of production, the firm, gross product, as well as inflation and unemployment.

The Law of Demand. When an individual want is expressed as an intention to buy, it becomes a demand. The law of demand is a theory about the relationship between the amount of a good that a buyer both desires and is able to purchase per unit of time, and the price charged for it. The ability to pay is as important as the desire for the good, because economics is interested in explaining and predicting actual behavior in the marketplace, not just intentions. At a given price for a good, economics is interested in the buyer's demand that can effectively be backed by a purchase. Thus, it is implied with demand that a consumer not only has the desire and need for a product, but also has the money to purchase it. The law of demand states that the lower the price charged for a product, resource, or service, the larger will be the quantity demanded per unit of time. Conversely, the higher the price charged, the smaller will be the quantity demanded per unit of time—all other things being constant. For example, the lower the purchase price for a six-pack of Coca-Cola, the more a consumer will demand (up to some saturation point, of course).

Demand Determinants. Movement along the demand curve—referred to as a change in quantity demanded—means that only the price of the good and the quantity demanded change. All other things are assumed to be constant or unchanged. These things include the prices of all other goods, the individual's income, the individual's expectations about the future, and the individual's tastes. A change in one or more of these things is called a change in demand. The entire demand curve will move as a result of a change in demand.

Law of Supply. The law of supply is a statement about the relationship between the amount of a good that a supplier is willing and able to supply and offer for sale, per unit of time, and each of the different possible prices at which that good might be sold. This law also states that suppliers will supply larger quantities of a good at higher prices rather than lower prices. In other words, supply generally is governed by profit-maximizing behaviors. The supply curve indicates what prices are necessary in order to give a supplier the incentive to provide various quantities of a good per unit of time. Just as with the demand curve, movement along the supply curve always assumes that all other things are constant.

Supply Determinants. At the opportunity for sale at a certain price, a part of total supply becomes realized market supply. Economics emphasizes movement along the supply curve in which the price of the good determines the quantity supplied. As with the demand curve, the price of the good is singled out as the determining factor with all other things being constant. On the supply side, these things are the prices of resources and other production factors, technology, the prices of other goods, the number of suppliers, and the suppliers' expectations.

Market Equilibrium. Supply and demand interact to determine the terms of trade between buyers and sellers. In theory, supply and demand mutually determine the price at which sellers are willing to supply just the amount of a good that buyers want to buy. The market for every good has a demand curve and a supply curve that determine this price and quantity. When this price and quantity are established, the market is said to be in equilibrium. The price and quantity at which this occurs are called the equilibrium price and equilibrium quantity. In equilibrium, price and quantity have the tendency to remain unchanged.

FACTORS OF PRODUCTION

Factors of production are economic resources used in the production of goods, including natural, man-made, and human resources. They may be broken down into two broad categories: (1) property resources, specifically capital and land; and (2) human resources, specifically labor and entrepreneurial ability.

Managers often speak of capital when referring to money, especially when they are talking about the purchase of equipment, machinery, and other productive facilities.

Financial capital is the more accurate term for the money used to make such purchases. An economist would refer to these purchases as investments. The economist uses the term capital to mean all the man-made aids used in production. It is sometimes referred to as investment goods. Capital consists of machinery, tools, buildings, transportation and distribution facilities, and inventories of unfinished goods. A basic characteristic of capital goods is that they are used to produce other goods. Capital goods satisfy wants indirectly by facilitating the production of consumable goods, while consumer goods satisfy wants directly.

To an economist, land is the fundamental natural resource that is used in production. This resource includes water, forests, oil, gas, and mineral deposits. These resources are rapidly becoming scarce. Land resources, which include natural resources above, on, and below the soil, are distinguished by the fact that man cannot make them.

Labor is a broad term that covers all the different capabilities and skills possessed by human beings. While this often means direct production labor, it includes management labor as well. The term manager embraces a host of skills related to the planning, administration, and coordination of the production process.

Entrepreneurial ability also is known as enterprise. Entrepreneurs have four basic functions. First, they take initiative in using the resources of land, capital, and labor to produce goods and services. Second, entrepreneurs make basic business policy decisions. Third, they develop innovative new products, productive techniques, and forms of business organization. Finally, entrepreneurs bear the risk. In addition to time, effort, and business reputation, they risk their own personal funds, as well as those of associates and stockholders.

THE FIRM

The economic resources of land, capital, and labor are brought together in a production unit that is referred to as a business or a firm. The firm uses these resources to produce goods that are then sold. The money obtained from the sale of these goods is used to pay the economic resources. Payments to those providing labor services are called wages. Payments to those providing buildings, land, and equipment leased to the firm are called rent. Payments to those providing financial capital, such as loans, stocks, and bonds, are called dividends and interest. In other words, capital goods tend to increase the productivity of labor through being man-made and reproducible.

GROSS PRODUCT

The total dollar value of all the final goods produced by all the firms in an economy is called the gross product. This commonly is measured by one or both of the following:

Gross national product (GNP) includes the value of all goods and services produced by firms originating in a single nation. This means that foreign direct investment (FDI)—such as a Japanese auto plant in the United States—is not included in GNP, even though the plant might employ U.S. workers and sell its output exclusively to U.S. consumers. Conversely, the value of production by U.S.-based firms abroad would be considered part of the U.S. GNP.

Gross domestic product (GDP) includes the value of all goods and services produced within a nation, regardless of where the owners of production are based. In this case, FDI into the United States would contribute to U.S. GDP, while U.S. investment in other countries would contribute to those countries' GDP, not that of the United States.

GDP is the preferred measure of gross product for many kinds of economic analyses. This is because foreign investment has grown rapidly around the world, and because foreign-owned assets, such as a manufacturing facility, tend to have a greater net influence on the domestic economy in which they are situated. Both measures of gross product calculate the value of products and services on a value-added basis so that output is not double-counted, such as when products are resold through different phases of the supply and distribution chain.

In order to make comparisons, economists often use “real” GNP or GDP, which means the figure has been adjusted to hide the effects of inflation, or the general rise of prices relative to the quantity or quality of goods produced. Therefore, real gross product is commonly taken as an indicator of overall economic health. A rise at a moderate, sustainable pace is considered healthiest. However, if gross product is declining or rising at an unsustainably fast pace, it usually is interpreted as a negative signal.

INFLATION AND UNEMPLOYMENT

The economic health of a nation, of which gross product is one measure, is directly affected by two other important factors: inflation and unemployment.

Inflation. Inflation is an ongoing general rise in prices without a corresponding rise in the quantity or quality of the underlying merchandise or services (i.e., getting “less for more”). Ultimately, inflation represents an economic imbalance and diminishes a currency's real and nominal purchasing power. The steeper the rise, the faster the decline of the currency's purchasing power. Rapid economic expansion is one factor that can lead to price inflation, as can lax or inconsistent control of the money supply (such as through central bank monetary policy). Leading measures of inflation in the United States are the

Consumer Price Index (CPI) and the Producer Price Index (PPI). When inflation data are used to adjust the estimate of GDP, it is known as the GDP deflator.

Unemployment. The unemployment rate measures the percentage of the total number of workers in the labor force who are actively seeking employment but are unable to find jobs. While this seems straightforward, there are some measurement issues to consider, such as what constitutes looking for a job, how part-time labor is interpreted (i.e., being underemployed rather than unemployed), and what happens when an individual is technically employable but not actively seeking employment for what ever reason.

Measurement difficulties aside, in general the higher the unemployment rate, the more the economy is wasting labor resources by allowing people to sit idle. Still, when unemployment rates are low there is a tendency toward wage inflation because new employees are harder to find and workers often require additional incentives in order to take or keep a job. Because having a moderate pool of unemployed workers serves as a buffer to rising labor costs, most economists view full employment (zero or negligible unemployment) as impractical and even undesirable. Structural unemployment seemingly allows human capital to flow more freely (and cheaply) when there are changes in demand for labor in various parts of the economy. Of course, this does not mean that high unemployment is viewed as positive.

SCHOOLS OF ECONOMIC THOUGHT

While many of the aforementioned basic economic principles and ideas are widely accepted by economists, there have been—and continue to be—differing theories about some areas of economic behavior. Following is a brief overview of the three most influential theoretical perspectives.

Classical Economics. Dating back to eighteenth-century Europe, classical economics posited the market system would ensure full employment of the economy's resources. Classical economists acknowledged that abnormal circumstances such as wars, political upheavals, droughts, speculative crises, and gold rushes would occasionally deflect the economy from the path of full employment. However, when these deviations occurred, automatic adjustments in prices, wages, and interest rates within the market would soon restore the economy to the full-employment level. A decrease in employment would reduce prices, wages, and interest rates. Lower prices would increase consumer spending, lower wages would increase employment, and lower interest rates would boost investment spending. Classical economists believed in Say's Law, which states that supply creates its own demand. Although more recent economic philosophies differ in some of the specifics, particularly on the role of governments, central banks, and international trade, many tenets of classical economics are still accepted today.

Keynesian Economics. As a consequence of the 1936 publication of British economist John Maynard Keynes's General Theory of Employment, Interest, and Money, mainstream economists came to give less importance to the role of money in the economy than had classical economists. Keynes sought to explain why there was cyclical employment in capitalistic economies. It was Keynes's analysis of how total demand determines total income, output, and employment, and the potentially key role for fiscal policy in the process, that captured the attention of most economists.

Moreover, the General Theory seemed to make compelling arguments for the use of government fiscal policy to avoid such problems and to smooth out economic instability. Keynesian followers believe that savings must be offset by investment. They termed propensity to consume as a person's decision on how much of total income will be allocated to savings and how much will be spent. The Keynesian view sees the causes of unemployment and inflation as the failure of certain fundamental economic decisions, particularly saving and investment decisions. In short, the Keynesian view is one of a demand-based economy.

Monetarism. More recently, the monetarists, led by Nobel laureate economist Milton Friedman, argued that money plays a much more important role in determining the level of economic activity than is granted to it by the Keynesians. Monetarism holds that markets are highly competitive and that a competitive market system gives the economy a high degree of macroeconomic stability. Monetarists argue that price and wage flexibility provided by competitive markets cause fluctuations in total demand rather than output and employment. Monetarism is thus concerned with controlling the money supply and not injecting excess liquidity into markets. This view is somewhat compatible with, but not identical to, the supply-side school of economics.

Economics

ECONOMICS

Economics is often described as a body of knowledge or study that discusses how a society tries to solve the human problems of unlimited wants and scarce resources. Because economics is associated with human behavior, the study of economics is classified as a social science. Because economics deals with human problems, it cannot be an exact science and one can easily find differing views and descriptions of economics. In this discussion, the focus is an overview of the elements that constitute the study of economics, that is, wants, needs, scarcity, resources, goods and services, economic choice, and the laws of supply and demand.

Every person is involved with making economic decisions every day of his or her life. This occurs when one decides whether to cook a meal at home or go to a restaurant to eat, or when one decides between purchasing a new luxury car or a low-priced pickup truck. People make economic decisions when they decide whether to rent or purchase housing or where they should attend college.

WANTS, NEEDS, AND SCARCITY

As a society, and in economic terms, people have unlimited wants; however, resources are scarce. Do not confuse wants and needs. Individuals often want what they do not need. In the automobile example used above, someone might want to drive a large luxury car, but a small pickup truck may be more suited to the purchaser's needs if he or she must have a vehicle for hauling furniture. Economic decisions must be made.

A resource is scarce when there is not enough of it to satisfy human wants. And human wants are endless.

Because of unlimited wants and limited resources to satisfy those wants, economic decisions must be made. This problem of scarcity (limited resources) must be addressed, which leads to economics and economic problems.

Figure 1 illustrates the relationships that exist relative to wants and scarcity. Many elements influence economic decisions. To better understand economics, it is critical to understand what is shown in Figure 1.

RESOURCES

Economic resources, often called factors of production, are divided into four general categories. They are land, labor (sometimes referred to as human resources), capital, and entrepreneurship.

Land

Land describes the ground that might be used to build a structure such as a factory, school, home, or church, but it means much more than that. Land is also the term used for the resources that come from the land. Trees are produced by the land and are used for lumber, firewood, paper, and numerous other products, so they are referred to as land. Minerals that come from the ground, such as oil that is used to make gasoline or to lubricate automobile engines, or gold that is used to make jewelry, or wheat that is grown on the land and is used in the production of bread and other products, or sheep that are raised for the wool they produce that is used to make sweaters are all described as land.

Labor (Human Resources)

Labor is the general category of the human effort that is used for the production of goods and services. This includes physical labor, such as harvesting trees for lumber, drilling for oil or mining for gold, growing wheat for bread, or raising the sheep that produce wool for a sweater. In addition to physical labor, there is mental labor, which is necessary for such activities as planning the best ways to harvest trees and making decisions about which trees to harvest. Labor is also involved when a doctor or surgeon analyzes and diagnoses (mental labor) before performing a medical procedure, then performs the procedure (physical labor).

Capital

Capital is input that is often viewed in two ways, much as is labor. Capital might be viewed as human capital—the knowledge, skills, and attitudes that humans possess that allow them to produce. The other type of capital is physical capital, which includes buildings, machinery, tools, and other items that are used to produce goods and service. Traditionally, physical capital has been a prerequisite for human capital; however, because of rapid changes in technology, today human capital is less dependent on physical capital.

Entrepreneurship

One special form of human capital that is important in an economic setting is entrepreneur-ship (often thought of as the fourth factor of production). Entrepreneurial abilities are needed to improve what we have and to create new goods and services. An entrepreneur is one who brings together all the resources of land, labor, and capital that are needed to produce a better product or service. In the process of doing this, the entrepreneur is willing to assume the risk of success and failure.

Many people associate entrepreneurship with creating or owning a new business. That is one definition of entrepreneurship but not the only one. An entrepreneur might create a new market for something that already exists or push the use of a natural resource to new limits in order to maximize efficiency and minimize consumption.

GOODS AND SERVICES

It takes land, labor, and capital that are used by an entrepreneur to produce goods and services that will ultimately be used to satisfy our wants. Goods are tangible, meaning they are something that can be seen or touched. The production of goods requires using limited resources to produce in order to satisfy wants. An example might be a farmer who grows grain. The farmer uses farm equipment manufactured from resources; ground is a natural resource that is used to grow the grain; and because the growth of grain depletes the nutrients in the soil, the farmer must use fertilizers to restore the nutrients. Limited resources are used to produce natural or chemical fertilizers, but they are necessary for crop production. Water might be used to irrigate the crop and enhance production. When the crop is ready for harvest, the farmer uses additional resources to complete the process—equipment, gasoline, labor, and so on—which results in a good that can be used or sold for use by others.

Services are provided in numerous ways and are an intangible activity. There is no doubt that one can often see someone providing a service, but the service is not something that someone can pick up and take home to use. An example of a service is a ride in a taxi through a crowded city. It takes resources for the owner or driver to provide the service, and a passenger is consciously aware of riding in a taxi. When the ride is completed and the provider has been paid, the passenger does not have anything tangible to hold except the receipt. However, resources have been used to provide the service. The automobile used as the cab, the fuel used to operate the cab, and the labor of the driver are all examples of resources being used to provide a service that will satisfy a want.

It is important to understand that because goods and services utilize resources that are limited, goods and services are also scarce. Scarcity results when the demand for a good or service is greater than its supply. Remember that society has unlimited wants but scarce resources. It is scarcity, then, that causes consumers to have to make choices. If individuals cannot have everything they want, they must decide which of the goods and services are most important and which they can do without.

ECONOMIC CHOICE

Opportunity Cost

When one makes economic decisions, it is because of limited resources. Alternatives must be considered. People make such decisions based on expecting greater benefits from one alternative than another. There is an opportunity cost involved in the choice. Opportunity cost is the benefit forgone from the best alternative that is not selected: individuals give up an opportunity to use or enjoy something in order to select something else.

Opportunity costs cannot always be measured, because it might be satisfaction that is lost. At other times, however, opportunity cost can be measured. Here are examples of each. Perhaps a student is studying hard for a final examination in a difficult course because a good exam score is critical to achieve the desired grade. Friends call to invite the student out for the evening. The alternatives are to study or to have fun. Being wise, the student selects studying instead of going out. It is difficult to measure the opportunity cost of having fun with friends. In the second example, the same studying student is asked to help someone clean a garage. If the person offers to pay the student $50 to clean the garage and the student chooses to study, the opportunity cost is easily measured at $50. In both these examples, opportunity cost is directly related to what was given up, not any other benefits that might result from the decision.

Circumstances also play a role in opportunity cost. Sometimes people are forced into a decision because of circumstances and the results may not always be optimal. For example, if someone is planning to relocate to a new city to start a new job and wants to sell a house before the move in order to be able to purchase a new house in the new location, the person may sell the house for less than the market price in order to complete the process. The opportunity cost is the value of what was given up in order to be able to purchase a new home. Every time a choice is made, opportunity costs are assumed.

Production

Another economic choice that must be made is related to production. This is illustrated in Figure 1. All four of the decisions must be made: What goods will be produced? How will production occur? How much should be produced? Who will be the recipients? All are decisions that influence production efficiency.

Efficiency is the primary element in deciding what to produce and how to go about the production process. Efficiency is producing with the least amount of expense, effort, and waste, but not without cost. If you take something away from a person to satisfy another person, one will be less happy and the other will be more happy. If a way can be found to make one person more happy without making the other person less happy, this would be efficient.

An example of economic efficiency might be the following. Assume someone owns a car and a friend does not own a car but does drive. The friend needs transportation regularly for a week. It happens to be a time when the car owner will be away on a business trip and therefore will not be using the car. It makes no sense for the friend to buy a car to use for such a short period of time, so the owner loans the friend the car for that week. The car owner is no worse off and the friend is better off. Economic efficiency has occurred in this situation. If the car owner had not loaned the car to the friend, there would have been waste because the friend would have had to buy or rent a car. It is wasteful to fail to take advantage of opportunities in which there is no loss of satisfaction to either party.

Production efficiency is a situation in which it is not possible to produce any more units of a good without giving up the opportunity to produce another good unless a change occurs in available productive resources. If a farmer is growing wheat to be sold for the production of bread, there is a point at which adding additional fertilizer to the soil would do no good. If the fertilizer were used on an oat crop in a different field, production could be increased for that crop. The way to increase the wheat production is to find different resources to make the crop better, such as irrigating the land to provide more moisture.

In the above example, it was suggested that different or additional resources might be used to increase production. This is necessary only after efficiency has been achieved. Additional resources would have to come from land, labor, capital, or entrepreneurship. It is most common that capital will be used most often to increase production. Capital is productive input that is increased by people. This is known as investment. Investment involves giving up what might presently be consumed in favor of producing something to consume in the future. If the farmer wants to increase wheat production in the future, something will have to be given up now in order to increase the resources available for future production.

Increasing human capital is critical to increasing production. This does not mean that more people must be produced, but rather that the knowledge and skills of humans must be increased. This can happen because of improvements in technology and new ways of satisfying wants. This involves the entrepreneurial factor that was described previously—the human element that figures out ways to improve and expand the resources that already exist.

Product Distribution

Getting goods into the hands of those who want them involves many choices. The economic system must decide how to divide the products that are produced among the potential recipients. Sometimes products can be divided equally among recipients, but normally this is not the situation. It must then be determined how the division will take place. In a capital-istic economic system, distribution is often determined by wealth. If two people have the same wants, the person who can most afford something will be able to acquire it.

THE LAW OF SUPPLY AND DEMAND

Production decisions are made based on demand for goods and services. Supply of goods and services is dependent upon demand for the same. Why do movies that are much more popular stay at theaters longer than those that are not as popular? Demand for the movie causes the theater operators to supply the showings that the consumer wants. Why does the room rate in a convention hotel go down on weekends? There is less demand on weekends because most convention-goers leave on Friday or Saturday and others do not arrive until Monday, so the supply of available rooms goes up. Hotel operators try to create more demand for their vacant weekend rooms by lowering prices and offering attractive amenities.

The law of demand states that during a specific time period the quantity of a product that is demanded is inversely related to its price, as long as other things remain constant. The higher the price, the lower the demand; the lower the price, the higher the demand. Do not confuse demand with wants. Consumers have unlimited wants, as was established at the beginning of this discussion. Nor are demands and wants the same as needs. A consumer may need to have a crown put on a tooth but may not want to have it done because of the high cost. At some point, the suffering patient may demand the services be provided regardless of the price.

Often when prices are too high and demand for a product or service lessens, it is because consumers have found a suitable substitute. Substitution happens all the time as a result of economic decisions that are made by consumers. For example, if someone needs a winter coat and likes one with a designer name and a price that reflects that name, the purchase may not be made. Instead, the person finds a similar coat that does not have a designer label and purchases it instead at a much lower cost.

Demand for goods or services determines the amount that will be supplied. The law of supply states that the greater the demand, the more that will be supplied; the lower the demand, the less that will be supplied. The amount that will be supplied by a producer of the good or service is based on capacity and willingness to supply the product at a specific price. A producer will not supply goods and services just because there is demand for them—price for the good or service is an important consideration.

If consumers are willing to pay more for a good or service, the producer will likely be willing to shift more resources in order to increase the supply of the demanded product. If a rancher is raising prime beef cattle and there is high demand for this good and consumers are willing to pay more for high-quality beef, then the rancher might be willing to supply more even if it is necessary to shift resources or acquire additional resources to be able to do so.

Demands change, supplies change, and prices change. So how does a producer know how much is enough and what price to charge for the goods and services? Very simply, the demand for and supply of goods and services can be plotted on graphs using different prices. The supply and demand for a good or service intersect on the graph at what is called the equilibrium price, or the price where all of what is supplied will be demanded. If the price is below equilibrium, there will be a shortage of the good or service, and if the price is above equilibrium, there will be a surplus of the good or service. For a more detailed explanation on this aspect of economics, see the discussion of supply and demand.

SUMMARY

Economics is a complex topic that is studied constantly and thoroughly. This article has given an overview of some of the main tenets of economics; however, there is much that was not even introduced. There are other topics throughout this encyclopedia, such as macroeconomics and microeconomics, that will further define and expand the topic of economics.

Economics

Pollution A to Z
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Economics

Economics is a social science that is applied to the production, distribution, exchange, and consumption of goods and services. Economists focus on the way in which individuals, groups, businesses, and governments seek to efficiently achieve economic objectives. General economics can be divided into two major fields:

Microeconomics, or price theory, explains how the interaction of supply and demand in competitive markets creates a variety of individual prices, profit margins, wage rates, and rental changes. Microeconomics assumes that people behave rationally, and that consumers generally spend their income in ways that give them as much pleasure as possible. For their part, capitalists are viewed as seeking as much profit as possible from their operations.

Macroeconomics deals with modern explanations of national income and employment. British economist John Maynard Keynes (1883–1946) explains macroeconomics as the total or aggregate demand for goods and services by consumers, business investors, and governments.

Economics of Pollution

The study of the economics of pollution as it relates to the environment must begin with an understanding of the nature of the economic system. This starting point is essential to any analysis of pollution economics because the basic cause of environmental problems is a specific type of market (economic) system failure.

Four Market System Goals

All economic systems that are formulated by various economists consider four central objectives: efficiency, equity, stability, and growth. Efficiency and equity concern the processes of production and consumption (and are concepts that fall under microeconomics). Stability and growth apply to the overall performance of an economy (and are concepts that fall under macroeconomics). When analyzed economically with regard to pollution (or any other subject), these four goals must be considered as interrelated.

Efficiency. The concept of efficiency is defined as the maximum consumption of goods and services given the available amount of resources. Perfect efficiency occurs when the market resolves all production and consumption decisions so that the market allocation of resources is such that all goods are being produced at the lowest possible cost. No government intervention is necessary in this scenario. In the complex U.S. economic system, perfect allocation efficiency is impossible.

One of the critical conditions for the analysis of pollution economics is that all costs and benefits be registered (or known) in the marketplace. With regard to pollution, environmental damage has resulted when all costs have not been recorded in the marketplace, either because they were ignored or, more recently, due to the fact that these costs cannot be properly defined. For example, the price of a gasoline-powered vehicle does not include the indirect costs that result from its production and use, such as air pollution and resultant health care. When such environmental damage is defined, then the government must intervene by regulating pollution, funding sewage treatment plants, and other such unmeasured production costs.

Equity. The concept of equity refers to the just (or equitable) distribution of total goods and services among all consumers. People own resources (such as their expertise and talents, along with property and land) that can be used in the production process. The more resources an individual owns, the more income that individual usually generates. This equitable distribution of income does not always hold in the real world. Economists, so far, have not developed a good theory of "equitable income distribution." As a result, equity considerations are generated on a need-by-need basis, usually by government actions such as minimum wage laws, social security benefits, and unemployment insurance.

The correction of existing pollution problems involves equity issues. What is fair to all those involved? The value of human and physical resources will be affected by changes in environmental regulations. For example, if a coal mine is forced to close because of environmental abuses, its workers will suffer. However, other local employees who work at the hydroelectric power plant will benefit directly with better wages and indirectly with cleaner air, water, and land. The coal mine workers will not consider this new arrangement very "equitable" in the redistribution of income, nor will the fishing business sector when fish cannot travel up the river past the dams to reproduce.

Stability. The concept of stability is defined as a system's ability to maintain a balance. A real-life economic system, such as in the United States, tends to be unstable. Adjustments in monetary and fiscal policies at the federal, state, and local levels are constantly being made. These policies are essential in order to strive for full employment and price stability.

Improvements in pollution control and prevention have far-reaching implications in economic stability. Large capital expenditures may be required for companies to install new pollution abatement equipment as ordered by the government. This action forces new capital and operating costs on such firms and—if large enough—can subject the macroeconomic system to instabilities.

Growth. The concept of growth refers to a system's ability to increase in size or intensity. The ability to regularly achieve economic growth must be present in economic systems. Standards of living will increase as long as the rate of output growth exceeds the rate of population growth. Again, a government acts within an economic system to provide ways (such as tax laws to promote the creation of capital goods) to provide stability.

Growth is the one goal that has been viewed critically by environmentalists. The more growth an economy generates, the more pollution it also generates. In theory, the more restraint that the government places on industry with respect to pollution controls, the more likely it is that those companies will decrease their growth rate. Society is then faced with a choice: more goods or less pollution. In fact, the U.S. economy demonstrated robust growth over the past several decades, despite an array of environmental laws and regulations that have cut pollution significantly.

Marginalism

One of the basic economic approaches is marginalism. This approach seeks a level of operation of some activity that will maximize the net gain from that activity (which is the difference between its benefits and costs). During any activity, the benefits and costs increase, but because of diminishing returns, costs will generally rise faster than benefits. At its maximum level, marginal costs (the cost of increasing the activity) equal marginal benefit (the benefit of increasing the activity) so the activity is said to be optimized, or maximized. In other words, further expansions will cost more than it is worth, and further reductions will reduce benefits more than it will save costs.

Pollution. Marginalism is easy to apply to pollution in the theoretical sense. Unfortunately, it becomes difficult to apply in the real world because of the inability to accurately estimate the cost and benefit functions of pollution. Realistically, pollution is not a question of "having" versus "not having," but rather what level is optimal. This is where marginalism can prove useful, when used accurately and when taking into account all facets of the problem. Even in this context, reducing the level of pollution will affect other areas.

For example, manufacturing car tires that last about 64,000 kilometers (roughly 40,000 miles) at a cost of $200 might contribute 3 percent to the smog in Detroit, Michigan, whereas manufacturing tires that survive approximately 96,000 kilometers (60,000 miles) at a cost of $300 might add 9 percent to Detroit's smog. Even though the consumer is able to buy tires that last 20,000 miles (or 50 percent) longer and only cost $100 more (representing an increase of 50 percent) than standard tires, it is not as good a deal for the smog count, which triples from 3 to 9 percent.

Self-regulating Economic System

Another concept that affects pollution is the self-regulating economic system. Under ideal conditions all the information necessary for making the best
decisions is known. If a manufacturer made a product with thorough knowledge of all costs of production, including environmental costs, then ideal decisions could be made. But, of course, this is not possible.

The efficiency of the competitive market depends on private costs (such as direct manufacturing expenses) and social costs (such as resulting pollution) being the same. When they are not equal, and when some of the costs are not known (i.e., some costs of pollution), the competitive market is not able to run at its maximum social efficiency. Thus, the failure to factor in all costs and benefits in the market can lead to pollution and environmental deterioration. Such inefficiencies of the market have produced pollution in many forms, including greenhouse gases and radioactive wastes.

U-shaped hypothesis. A widely held view by environmental economists is that economic growth does inevitably lead to the increasing pollution of air, water, and land. However, a diversion of resources to pollution control and general environmental objectives will eventually follow. That is, as prosperity increases (based on rising gross domestic product per capita), a more closely watched environmental program slowly replaces the former lack of concern with the environment. Evidence of this inverted U-shaped graph is already clear in many developed countries, such as the United States and England. See the graph for an an illustration of the hypothesis.

In phase one a country begins to develop, and growth (increasing at a rapid pace) exceeds pollution. Greenhouse gases, radioactive wastes, and pollution in small bodies of water start to increase. In phase two a country begins to mature, and pollution equals growth (although growth continues to increase). Pollution and wastes have accumulated and pollution becomes noticeable in larger bodies of water, such as oceans and seas. In phase three a country recognizes its pollution problems, and pollution is allowed to
decrease along with increasing growth. Measures to counteract pollution are instituted, such as sanitation, treatment, regulations, and zoning.

Measuring Pollution

Determining pollution problems and costs in the United States (or any country) may appear relatively simple. Unfortunately, this is far from the truth. In reality, there is generally a lack of accurate and comprehensive information on the condition of the environment in industrialized countries (and even more so in developing countries). In general, a lack of sufficient understanding by scientists of environmental phenomena and the elements in which to measure them still does not allow a comprehensive definition and evaluation of critical data. For example, it is easy to estimate the cost to fishers who have a reduced catch based on industrial pollution in the waters. But there are other, less straightforward costs to be considered, such as the loss of recreational opportunities on those waters and the loss of consumers in the consumption of those fish. In addition, it is difficult to know whether all the pollution came from industry, or whether other sources such as agricultural
runoff were just as guilty. On the positive side, sufficient data are available that can be used to evaluate the major sources of pollution.

Pricing Pollution

One way to measure pollution is to place a price on it. Under such a system, anyone could emit pollution as long as one paid a set price for it. In this way, an approximate marginal social cost of pollution is established and decisions can be made based on that knowledge. Pricing pollution can simplify the process of dealing with pollution, and in the long run, provide a comprehensive and efficient way of handing the problem.

Any effort to restore and maintain the integrity of the environment imposes a burden on society with respect to additional costs. The magnitude and complexity of those costs are of great importance. To understand these costs and the benefits that a better environment can provide to society, economists study and analyze pollution through the methods of environmental economics. By doing this, society, in general, is forced to question the relationship between the institutions of society and the environment. In no certain terms is that relationship an easy one to study; it also makes a final determination of short-term—and even more difficult—long-term solutions hard to ascertain.

How can society best establish a high quality of life? The answer might be to enjoy pure mountain streams, breathe in clean air, and hike in pristine forests; the answer, however, might also be to enjoy good food and drink, comfortable housing, and convenient transportation systems. Environmental economics helps to determine the combination that individuals or groups believe is most desirable.

Economics

Encyclopedia of Science and Religion
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Economics

The field of economics encompasses the study of how natural resources are drawn from nature and processed by human activity to become value-added products for consumption or commodities for exchange; the study of how complex services are developed by coordinating human activities so that particular services can be rationally provided, bought, or sold; and the study of how the resulting resources are allocated, and how the costs and benefits of these processes are calculated.

Highly specialized subdisciplines of this vast field developed after the Industrial Revolution, the rise to social dominance of the modern business corporation, the sharp debates between capitalist and socialist theories during the nineteenth and twentieth centuries, and the increased globalization of the contemporary world. Econometrics seeks to measure actual processes and their consequences in a delimited institutional range—a family, firm, nation, industry, or segment of the population such as a race or a class. Regression analysis seeks to develop models that can interpret the relative effects of a variable or a set of variables. Other subdisciplines focus on policy-making and are intended to bring desired social results. Macro-economics, for example, focuses on tax or other governmental policies that aim to enhance development or public services, reduce poverty or inequality, or control behaviors that damage the common welfare (crime, environmental damage, drug abuse, child pornography, health or safety, etc.). Microeconomics seeks to enhance the efficiency, productivity, profitability, and viability of companies that operate in various markets. Labor economics, which often engages in advocacy, studies both political and business policies from the standpoint of their effects on employees and workers' unions. Despite their differences in focus, experts in all economic subdisciplines agree that without a sound economic infrastructure, societies falter and people suffer.

History

Economic activity has always been a part of human existence. Hunting, gathering, and cooking have taken place since humans first appeared. Production by craftsworkers to supply goods for trade and for merchants has been present in all of recorded history. Early theories of economic life date back to discussions about farmers and peddlers in the Arthashastra, an Indian treatise on governance from about the third century b.c.e. The concept of shangye (commercial occupation) in early Confucian texts sought to spell out the relationships of economic actors to political and social life. Economic theories also turn up in ancient Greek writings. Plato (c. 428–347 b.c.e.) saw the foundation of The Republic as rooted in economic life (Book 2), and in Politics Aristotle (384–322 b.c.e.) developed the idea of the "management of the household" (oikonomia ) and applied it to the polis.

Moreover, economic issues were taken up by religious prophets and moral philosophers in all known cultures, and in the West the blend of biblical themes and Greek philosophy has decisively shaped the social and ethical perceptions of economic life and policy. That is so despite the fact that economics in its modern mode has sought to differentiate itself from these social, ethical, and spiritual philosophies. Indeed, it has become a truly autonomous science on the model of the natural sciences since, at least, the French physiocrats and the English post-mercantilist economists from Adam Smith (1723–1790) through the utilitarians to John Maynard Keynes (1883–1946) and the German socialists and the Austrian libertarians. It is these modern Western sets of perspectives and debates that have most shaped what is today understood as the discipline of economics.

Economics as a discipline, for all its achievements, is not identical to economic life. The heirs of Adam Smith, and those of Karl Marx (1818–1883) or Friedrich Hayek (1899–1992), have developed refined theories that describe how the "rational choices" of persons, families, classes, governments, businesses, or market mechanisms (such as a stock exchange, employment and wage rates, or a futures market) typically manifest themselves, although economists know that they are working with abstract models. The great advantage of such models is that they can be developed and applied in many concrete circumstances by ruling out idiosyncratic and extrinsic contingencies that may also influence decisions or policies but are not directly economic factors. The best economic theories not only have a mathematical and philosophical mark of elegance, they also have a high degree of reliability when applied to specific questions and adjusted to specific contexts.

These models work best in an environment that shares a common society, a common culture, and, since they deeply influence the perceptions and expectations of persons and communities, something of a common set of religious convictions. That is because the "conditionalities" of behavior, what strict economic theory considers to be idiosyncratic or extrinsic contingency, are different where divergent cultural, social, or religious convictions shape morality in distinctive ways. It is true that no one wants to be cheated and that stealing or exploitation is recognized as wrong in every culture, even if it occurs. And it is true that people seek the well-being of the persons or groups that are most important to them in all sorts of social, cultural, or religious conditions. But it is also the case that a polygamous tribal person, for example, or a Hindu caste member, a dedicated leader of an Islamic brotherhood, or a Buddhist nun will have different senses of what constitutes the well-being of persons and groups. It is, thus, not at all surprising that the banking systems in different parts of the world are operationally different, that corporations are formed in distinctive ways and led with diverse understandings of the proper role of leadership, and that workers variously evaluate their obligations to firm, family, nation, political ideology, and faith.

Basic disputes and issues

The attempts to account for these contextual differences are among the key subjects of cultural studies, the sociology of religion, and comparative religious ethics to the extent that these fields bear on economic matters; the issues are paralleled by political, legal, and aesthetic studies. In the West, John Locke (1632–1704) and Thomas Hobbes (1588–1679) can be considered exemplars of a primal disagreement about how economic life works in society. For Locke, persons have a right to their "proprium, " that property that they appropriate from nature by honest labor and that is necessary both for their individual existence and for the support of their family. On these bases, people form a civil society with others and construct a political society for the protection of their own and others' well-being. They are aided in this effort by the fact that all persons can, in some measure, recognize the "self-evident truths" of a universal moral law, guaranteed both by reason and by Christian scripture. If the political society does not work, or violates the moral law, the people have a right to alter it to restore their economic and social well-being.

For Hobbes, perpetual conflict over scarce resources could not be resolved by either reason or religion, and thus a sovereign had to impose a collective order by force. Politics must control economics, and no rebellion was allowed. The obvious and brutal conflicts of interests, ideologies, and religions demanded state power so that economic well-being could be obtained beyond the natural state of war. In this paradigmatic dispute, one finds not only the question of the relationship of the bee to the hive in economic life, but the issue of the relative priority of civil society to political society as determinants of economic existence.

A second set of disputes can be seen in the controversies of those who follow Georg Wilhelm Friedrich Hegel (1770–1831) and those who follow his disputatious disciple, Marx. Hegel held that spiritual or mental (geistliche ) realities fundamentally shape material realities in a decisive dialectic. Marx, famously turning Hegel on his head, argued that it was not "superstructural" factors that shaped "substructural" factors, but rather the material realities of life that determined human consciousness. Any correlation between religious orientation and economic life was an effect of economic forces that evoked the religious sighs of the people, while those who had control of the means of production perpetuated these dreams to control the workers.

These theories combine in mixed ways. A version of the materialist view can be found among various contemporary disciples of Charles Darwin (1809–1882). Some of them, including the Nobel Prize winning economist Gary Becker (1930–), hold to an "evolutionary psychology" in which individuals make "rational choices" about not only business matters but also about whom to marry and whether to have children on the basis of their calculation of material interests. A collectivist view of economic behavior is set forth by Edward O. Wilson (1929–) in his sociobiological theories; this view sees religion as an illusory cultural by-product of collective material and instinctual dynamics.

More influential in the understanding of the relationship of religion and economic life is the work of Max Weber (1864–1920). His five volumes on the Sociology of Religion and his three volumes on Economy and Society, written early in the twentieth century, argued that different religions have distinct effects on economic (and political) life and on various classes and occupational groups in society. Weber saw not only that the late medieval Roman Catholic faith had an economically positive influence in the emerging free cities of northern Europe in the very early stages of modernity, but that the Protestant ethic gave impetus to the formation of what is now known as the break with traditional, feudal economies and the development of modern capitalist industries. Weber's arguments were doubted during the harsh realities of the Great Depression (which saw greater use of Marxist theory and the rise of Fascism), and were often ignored after World War II when Keynes's economic theories came to ascendancy, but Weber's work regained attention after the collapse of the Soviet Union in the early 1990s and the resurgence of religion all over the world. Today, few economists think that Weber's treatments of India and China were fully adequate, and questions about aspects of his views of Catholicism, Protestantism, and Islam are manifold. Yet, it is widely held that the questions he raised and the methods of investigation he developed are among the most definitive for the ongoing discussions between religion and economic life.

In a postmodern age, the predicted certainties of inevitable secularization that seemed beyond dispute, of a purely scientific view of reality that could provide firm foundations for progressive public policy, clear-minded corporate decisionmaking and personal rational choices without illusion, and the end of both ideology and religious myth seem positively silly. Indeed, it turns out that a deep convergence of inter-contextual reasonability and moral conviction, not equally available in all religions, are critical for the economic wellbeing of persons and peoples. The body of contemporary literature that points in this direction is found in a host of Weber-influenced studies that document the interactions of religion and economic life, and point out that the basic assumptions behind contemporary secular economic theory are, in fact, echoes of religious convictions that are well, but not fully, masked.

economics

The Columbia Encyclopedia, 6th ed.

Copyright The Columbia University Press

economics, study of how human beings allocate scarce resources to produce various commodities and how those commodities are distributed for consumption among the people in society (see distribution). The essence of economics lies in the fact that resources are scarce, or at least limited, and that not all human needs and desires can be met. How to distribute these resources in the most efficient and equitable way is a principal concern of economists. The field of economics has undergone a remarkable expansion in the 20th cent. as the world economy has grown increasingly large and complex. Today, economists are employed in large numbers in private industry, government, and higher education (see economic planning). Many subjects, such as political science and sociology, which were once regarded as part of the study of economics, have today become separate disciplines, although the study of any one generally implies a working knowledge of the others.

Ancient and Medieval Periods

The first attempts to analyze economic problems appear in the writings of the ancient Greeks. Plato recognized the economic basis of social life and in his Republic organized a model society on the basis of a careful division of labor. Aristotle, too, attributed great importance to economic security as the basis for social and political health and saw the owner of a middle-sized plot of land as the ideal citizen. Roman writers such as Cicero, Vergil, and Varro gave significant advice about the economics of agriculture. The medieval period was marked by the disruption of the flourishing commerce of the ancient world, and its economic life was dominated by feudalism. Economic writings of the age focus on the just price for goods and criticism of usury.

Mercantilism, the Physiocrats, and Adam Smith

In the transition to modern times (16th–18th cent.), European overseas expansion led to the growth of commerce and the economic policies of mercantilism, a system that inspired a substantial body of literature on the subject of economic nationalism. In the late 17th and the 18th cents., protest against the governmental regulation characteristic of mercantilism was voiced, especially by the physiocrats. That group advocated laissez-faire, arguing that business should follow freely the
"natural laws"
of economics without government interference. They regarded agriculture as the sole productive economic activity and encouraged the improvement of cultivation. Because they considered land to be the sole source of wealth, they urged the adoption of a tax on land as the only economically justifiable tax.

In the 18th cent. important work in economics was done by the Scottish philosopher David Hume. His analysis of the natural advantages that some nations enjoy in the cultivation of certain products and his observations on the flow of commerce became the basis for the theory of international trade. The most important work of the 18th cent., however, was Adam Smith's An Inquiry into the Nature and Causes of the Wealth of Nations (1776), which is considered by many to be the first complete treatise on economics. Smith identified self-interest as the basic economic force and, through his analysis of the division of labor and his comprehensive study of the development of economic institutions in the West, established economics as a major area of study. John Millar, a follower of Smith, incorporated and developed these ideas into a highly sophisticated economic interpretation of history. Smith's theories, especially his advocacy of free trade, played an important part in the Industrial Revolution then taking place in Britain.

Malthus, Ricardo, and Mill

One of the most influential writers of the 19th cent. was Thomas Malthus, whose predictions that population growth would always tend to outstrip advances in the means of subsistence earned for economics the title
"the dismal science."
The most important economist to follow Smith was David Ricardo. His analysis of rent long remained the classic account, while his theory of labor value was later adopted by socialists as well as classical economists. Ricardo's
"iron law of wages"
supplemented Malthus's pessimistic thesis by asserting that wages tend to stabilize at the subsistence level. John Stuart Mill was a follower of Ricardo and contributed to the study of international trade as well as to the study of the economics of industrial expansion. Among critics of free trade outside Britain were the German Friedrich List and the American Henry C. Carey.

The Socialists and Marx

The early exponents of socialism, especially in France, attacked the idea of the necessity of private property and competition and were interested in revamping the economic and social order. Among those were C. H. Saint-Simon, Robert Owen, Charles Fourier, and Louis Blanc. In Germany the historical school arose under Wilhelm Roscher, Bruno Hildebrand, and Karl Knies, who doubted the existence of universal economic laws and emphasized the particular development of economic institutions in individual nations.

The greatest challenge to classical economics came from the followers of Karl Marx. Marx's critique of capitalism was moral and social, as well as economic; but in the exposition of the workings of the capitalist system he and his followers developed important insights into the structural weaknesses of the market economy, especially the recurrence of economic crises (see depression).

Further Evolution of Classical Economics

At the same time as Marx was writing, the principles of classical economics were being reformulated and refined—it was at this time that the term
"economics"
replaced the term
"political economy,"
which had been used through the mid-19th cent. The most important refinement was the doctrine of marginal utility, which asserts that the value of an item is determined by the need for it and by its relative scarcity or abundance at any given time—not by any intrinsic or inherent worth. The leading theorists in the development of the concept were William Stanley Jevons of Britain, Leon Walras of France, and Carl Menger of Austria. In the United States, John Bates Clark was notable in the development of marginal utility theory, forming his own hypothesis regarding the distribution of wealth. Classical economics reached its fullest expression at the end of the 19th cent. in the work of Alfred Marshall. Marshall used mathematics to perfect the application of classical techniques and introduced important modifications to the notions of competition, marginal utility, and rent.

Keynes

Swedish economist Knut Wicksell was influential in the development of monetary theory, which concerned itself with overall price levels and interest rates in an economy. His work foreshadowed the most important modification of classical concepts of the free economy, exemplified in the work of John Maynard Keynes. In his General Theory of Employment, Interest, and Money (1936), Keynes opened up a whole new range of investigation into business cycles. A principal result of Keynes's teaching has been reflected in governmental attempts to control the business cycle by putting money directly into the economy; the
"pump-priming"
technique, often accompanied by an unbalanced budget, is now a part of most capitalist economic systems.

Since World War II

After World War II, emphasis was placed on the analysis of economic growth and development. Western economists notable for their contributions to the economics of growth and development include Gunnar Myrdal of Sweden, Sir Arthur Lewis of Great Britain, and Joseph Schumpeter of the United States.

In recent years, economic theory has been broadly separated into two major fields: macroeconomics, which studies entire economic systems; and microeconomics, which observes the workings of the market on an individual or group within an economic system. The use of complex mathematical techniques and statistical data in economic forecasting has resulted in a new branch of economics known as econometrics. British economist Arthur Pigou was influential in the development of welfare economics, an important branch of the discipline that suggested that an economic system was better if even one person's satisfaction was increased while no one else's was decreased.

In the 1980s supply-side economics (which sees economic growth as essential for improving the material health of society) was used as a policy tool by the Reagan administration. Another modern economic school that was influential in the Reagan years is monetarism; monetarists, such as Milton Friedman, believe that the money supply exerts a dominant influence on the economy. In the 1990s, Nobel laureate Gary Becker extended the scope of macroeconomic analysis by applying economic reasoning to human behavior, including the use of sociology, anthropology, and other disciplines. Game theory has also been appied to economics (see games, theory of).

Political Economy

Political Economy

The phrase political economy came into currency in the seventeenth and eighteenth centuries. It is natural to think that the name refers to a discipline that studies how politics affects the economy and vice versa. Yet the fundamental idea of the original political economists—Adam Smith, David Ricardo, Thomas Malthus—was that an economy works best when governed least. They believed that there were economic principles that tended to produce the common good if government generally left people alone in their material endeavors. Adam Smith’s (1776) famous remark about “the invisible hand” puts the idea succinctly: an individual, through his industry,

intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.… By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. (p. 456)

This invisible coordination of individual interest will result in the general welfare only if government allows the market to run on its own principles. It is ironic that the founders of political economy—the “classical economists,” as they are now called—rejected a large role for politics in the economy.

While there is irony in calling this view political economy, it nonetheless has a rationale. The term economics derives from the Greek word for “household.” For much of human history, the individual household was expected to meet the needs of its members through its own efforts, without significant help from the state. Nation-states came into being only in the sixteenth and seventeenth centuries, and they were soon expected to have the ability and duty to improve economic well-being. Mercantilist and physiocratic theories were the first expressions of this concern. Both of these, but especially mercantilism, demanded significant intervention in the economy, including protectionist measures to improve a nation’s balance of trade.

The political economists reacted to these earlier theories. Their aim was to reveal the proper aim of political activity in economic life. The name political economy still made sense for their discipline, even though the proper aim was negative, a matter of minimizing interference.

The next iteration in the life of the phrase political economy came with the work of Karl Marx in the mid-nineteenth century. For Marx, the economy dominates politics. In every era (until the final era of communism) there is an economic structure that benefits certain classes and exploits others. The rest of social life, including the state, the law, culture, and dominant ideas and values, exists only to promote the economic structure and to further the interests of those on top. Marx is reasonably categorized as a political economist, given the linkage he sees between economics, politics, and the rest of social life.

There is, however, another irony about the use of the phrase political economy here. Marx’s most important economic work, Capital, is subtitled A Critique of Political Economy. His central ideas about society are most clearly laid out in the famous preface to a different work entitled A Contribution to the Critique of Political Economy. Marx thus took himself to be rejecting political economy. He was rejecting (“critiquing”) the ideas of the classical economists such as Smith and Ricardo. Nevertheless, since he linked economy, politics, ideology, and culture, it became reasonable for later generations to think of Marxism as the archetype of political economy. For many today, political economy means Marxist and nonorthodox explanations of political, legal, and cultural phenomena, and also mainstream ideas by reference to the economic forces they are said to uphold.

By the end of the nineteenth century the phrase political economy gave way to the word economics. Marginal utility theory, also known as neoclassical economics, developed. Perhaps the strongest ground for the name change was the desire to develop a discipline both independent and scientific, based on the rigorous mathematical tools and laws that marginal utility theory put forth to explain production and exchange. Neoclassical economic thinkers wished to disentangle their discipline from the normatively tinged areas of politics, philosophy, and the moral sciences generally. Thus the concept of political economy slowly gave way to the more scientific-sounding idea of economics. The phrase political economy has, however, remained in favor among those who want to resist the narrowness of modern neoclassical economic theory and insist that economic phenomena can only be fully understood through an understanding of the roles played by politics and culture.

Another use of the term political economy has developed in the last half century in the work of public choice theorists such as James Buchanan, Gordon Tullock, and Mancur Olson. These scholars seek to explain the behavior of groups, especially governments, on the basis of the idea, central to modern economic theory, that people tend to act as individual utility maximizers. Roughly put, public choice theorists argue that through the political process, politicians attempt to capture benefits for specific groups from the resources of the population generally (“rent seeking”). Thus, citizens are taxed to pay for benefits they do not receive, and the economy is made inefficient. Public choice theorists tend to respond to this “government failure” by returning to the original idea of the classical economists—the less government the better.

In recent years, the idea of political economy has come into use among those interested in global problems. International political economy studies national development and the planetary distribution of wealth. It examines the effects of economic globalization on human wellbeing, politics, law, culture, the environment, national sovereignty, and religion. Perhaps the most important question is the effect of economic globalization on the rich and poor. Thinkers scrutinize such organizations as the International Monetary Fund, the World Bank, and the World Trade Organization. Some argue that these represent a modernized version of neoclassical economics, labeled neoliberalism, that tends to work in favor of the rich and powerful and against the weak and poor. Others argue that free trade and liberalized flows of capital and labor will eventually improve the prospects of the global poor. The continuing debate about these issues gives political economy a new meaning in the global context.

the practice of promoting trade between two countries through agreements concerning quantity and price of commodities. Cf. multilateralism.—bilateralistic , adj.

boycottism

the principles behind, and means of carrying out, a boycott. —boycotter , n.

cameralism

the theories and adherence to the theories of the cameralists. —cameralist , n. —cameralistic . adj.

cameralist

a mercantilist economist of the seventeenth and eighteenth centuries who believed in the doctrine that a nation’s wealth could be made greater by increasing its supply of money. —cameralistic , adj.

capitalism

a system of economics under which ownership of and investment in the means of production and distribution depends chiefly upon corporations and private individuals. —capitalist , n. —capitalistic , adj.

cartelism

the practice of controlling production and prices by agreements between or among international companies. —cartel , n.

chrysology

the study of the production of wealth, especially as attained from precious metals.

Cobdenism

the economic doctrines of Richard Cobden (1804-65), who believed in peace and the withdrawal from European competition for balance of power.

Colbertism

the mercantilist theories of Jean Colbert in the 17th century, especially his advocacy of high protective tariffs.

commercialism

1 . the principles, practice, and spirit of commerce.

2 . an excessive emphasis on high profit, commercial success, or immediate results.

the principles and practices associated with the utilization of economic goods.

disintermediation

an economic phenomenon of the late 1970s and early 1980s in which investors, flnding that conventional savings and thrift methods did not pay sufficient interest to keep pace with inflation, transferred their funds to the money market and related savings and investment instruments, leading to a rapid growth in those resources and a loss of funds from institutions like savings banks.

economese

language and jargon typical of economists and the field of economics.

econometrics

mathematical methods used in the science of economics to prove and develop economic theories.

economics

the study of the production, use, and consumption of goods and services in society. —economie , economical , adj. —economist , n.

a late 19th-century English movement that favored the gradual development of socialism by peaceful means. —Fabian , n., adj.

Fordism

the theory of Henry Ford stating that production efficiency is dependent on successful assembly-line methods.

industrialism

a system of social and economic organization based upon highly mechanized industry. —industrialist , n., adj.

inflationism

the quality of advocating economic inflation. —inflationist , n.

joint stockism

the principle of contribution and division of capital or stock by a number of persons.

Keynesianism

the economic theories of John Maynard Keynes (1883-1946), English economist, and his advocates, especially his emphasis upon deficit spending by government to stimulate business investment. —Keynesian , n., adj.

laissez-faireism

the economic doctrine that the government should intervene as little as possible in economic affairs. —laissez-faireist , n., adj.

macroeconomics

the division of economics dealing with broad, general aspects of an economy, as the import-export balance of a nation as a whole. Cf. microeconomics . —macroeconomist , n. —macroeconomic , adj.

Malthusianism

the theories of Thomas Malthus (1766-1834), English economist, stating that population growth tends to increase faster than production and that food and necessities will be in short supply unless population growth is restricted or war, disease, and famine intervene. —Malthusian , n., adj.

Manchesterism

the policies and principles of an English school of economists based in Manchester. —Manchesterist , n.

mercantilism

a political and economic policy seeking to advance a state above others by accumulating large quantities of precious metals and by exporting in large quantity while importing in small. —mercantilist , n. —mercantilistic , adj.

microeconomics

the division of economics dealing with particular aspects of an economy, as the price-cost relationship of a business. Cf. macroeconomies . —microeconomist , n. —microeconomic , adj.

monetarism

1 . an economic theory maintaining that stability and growth in the economy are dependent on a steady growth rate in the supply of money.

2 . the principle put forward by American economist Milton Friedman that control of the money supply and, thereby, of rate in the supply of credit serves to control inflation and recession while fostering prosperity. —monetarist , n., adj.

multilateralism

the practice of promoting trade among several countries through agreements concerning quantity and price of commodities, as the Common Market, and, sometimes, restrictive tariffs on goods from outsiders.

nationalization

the act or process of the taking over of private industry by government. See also 185. GOVERNMENT .

Neo-Malthusianism

the belief that the use of contraceptives as a means of lowering the population will eliminate such adverse elements as vice and elevate the Standard of living. —Neo-Malthusian , n., adj.

Owenism

the principles of social and labor reform along communistic lines developed by Robert Owen (1771-1858). —Owenite , n.

pastoralism

the herding or tending of cattle as a primary economic activity or occupation. Also pasturage . —pastoralist , n. —pastoral , adj.

plutology

the branch of economics that studies wealth; theoretical economics. Also called plutonomy .

privatization

the act or process of transferring to private ownership industry operated by a government, of ten industry that has been nationalized. See also 185. GOVERNMENT .

protectionism

the theory or practice of a method of fostering or developing industry through restrictive tariffs on foreign imports. —protectionist , n., adj.

Reaganomics

the economic theories and policies of the administration of President Ronald Reagan (1981- ), basically a policy of supply-side economics with emphasis on defense spending, encouragement of private and corporate development and investment, and reduction in government spending on social services.

Ricardian

a believer in the economic theories of David Ricardo, English economist, especially that rental income is an economic surplus. —Ricardian , adj.

Saint-Simonism

the theory of the Comte de Saint-Simon (1760-1825), who proposed a socialism in which all property and production be state-controlled with distribution on the basis of an individual’s job and ability. —Saint-Simonist , n.

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Another taxonomic variable is population. The Middle East has countries with large populations—Iran, Egypt, Turkey, Morocco, and Algeria. Others, such as Qatar and the U.A.E., have minimal indigenous populations.

The production of oil per capita tends to define the type of economy to which each Middle Eastern country belongs. Countries with oil production of more than 0.25 barrels per day per capita tend to emphasize the development of low-labor, high-capital industries. Saudi Arabia, U.A.E., and Qatar have sought to develop alternatives to their dependence on crude oil by investing heavily in industry, mainly in petrochemicals, which require large amounts of natural gas or crude oil, energy, and capital, but minimum labor. Until 1995 most of the development in oil and petrochemicals was spear-headed by the governments, with some support from the private sector. Due to lessening income streams from lower oil prices, efforts are being made to include private industry more fully.

The non-oil economy in the countries with high per capita oil output tends to be liberal, except in Libya. None of the countries in this group has any foreign-exchange controls, restriction on import or export of capital by nationals, or limits on imports and exports of products (except pork products and alcohol). Most prices are set by supply and demand, although some food staples are subsidized by the governments.

The countries with production between zero and 0.10 barrels per day per capita mostly have large populations. Some are minor oil producers, but major producers like Iran, Iraq, and Algeria have a low production per capita. These low per capita producers tend to emphasize centrally planned industrial growth with more labor content. They have very stringent regulations on investments and on foreign-exchange and capital export by residents. Large segments of their economy tend to be nationalized, including banks, mining, and large manufacturing plants. Their economic growth has been minimal, and most are attempting to deregulate their economies.

The final group (Turkey, Egypt, Morocco, Jordan, etc.), with very limited earnings from oil,

country

oil production average 2002 in thousands of b/d

population in thousands

bbls/capita

reserves in billions of barrels 2001

gdp in billions of $

source: this table compiles information from middle east economic survey, vol. xlv, 2002; the eia country analysis briefs (available from <http://www.eia.doe.gov/emeu/cabs/contents.html>); and the u.s. state department country background notes (available from <http://www_state.gov>)

relies on private local and foreign investment as well as foreign aid to fund their development.

A large segment of the population in the Middle East is active in agriculture (35.35%). However, this average is skewed by the large numbers of people employed in that sector in Egypt (43%) and Morocco (50%). Mining, manufacturing, and construction employs about 20.57 percent; public administration and services employs 23.54 percent; and trade, transport, and communication employs 9.27 percent.

Oil producers tend to have a much larger percentage of their population in public administration and services, suggesting that oil resources are downstreamed to the population through the creation of jobs in the civil service (34% in Saudi Arabia, 40% in Qatar, 39% in Iraq, 53% in Kuwait).

See also
Petroleum, Oil, and Natural Gas.

Bibliography

Gause, Gregory. Oil Monarchies: Domestic and Security Challenges in the Arabian Gulf States. New York: Council on Foreign Affairs, 1994.

political economy

political economy In the strict sense, an influential body of writings on economic questions associated principally with the French and English Enlightenment of the eighteenth century, and which culminated in the economic theories associated with Adam Smith. However, because the nineteenth-century classical economists who built on Smith's ideas continued to refer to their work as political economy, some vagueness and broadening of the use of the term occurs in social science literature. It is, in fact, in the broad sense rather than the narrow sense that classical sociology is widely viewed as a critique of political economy.

Early political economy resulted from the combined influence of the following: the progressive substitution of rationalism and science for the religious modes of thought in philosophy, and the attempted application of empirical methods to moral and social questions; the rise of capitalistindustrialism and the need to give an intellectual and ideological account of the emergent economic order; hostility to the so-called mercantilist policies still being pursued by governments and which attributed the prosperity of states to a favourable balance of foreign trade. Though political economy was never a unified doctrine, its characteristic outlook stemmed from attempts to show that surpluses of value originate from production, in particular from productive labour, rather than trade as such. For the Physiocrats (and to some extent perhaps Smith himself), agriculture is the only source of surplus, but political economy from Smith onward also recognized the importance of manufacture and the overall organization of productive activities through the division of labour. This, they argued, should not be hampered by mercantilist efforts to control prices, wages, and money. Indeed, money is a mere symbol of value, not its source.

Though Smith's famous treatise in support of free-market exchange. The Wealth of Nations (1776), is taken as the beginning of the modern discipline of economics, he and his distinguished contemporaries of the Scottish Enlightenment (such as Adam Ferguson) also wrote about a wide range of social, moral, and historical issues, much of which can be viewed as early sociology. However, the sociological element implied a more holistic view of society than did the economic doctrines. The latter are sharply individualistic, and in stressing the role of self-interest as the basis of co-operative order, contain in embryo form some key elements of what has since come to be known as rational exchange theory. But the later separation of economics from other disciplines would have been wholly alien to early political economy. This separation owes much to the fact that the so-called classical economists of the next generation, notably David Ricardo and his disciples among the nineteenth-century English utilitarians, began to abstract the economic ideas from the rest and to formalize them—a process which has continued ever since. Despite their many divergences in outlook and purpose, Karl Marx, Max Weber, Émile Durkheim, and the other founders of sociology shared a conviction that the abstraction of the economic from other aspects of social life ignored crucial questions about the nature of modernity and capitalist production itself.

So-called radical political economy is a term associated with the renaissance of Marxist thought in the 1960s. Hostile to functionalist-dominated academic sociology and economics in the United States and Britain, it sought to transcend the (from its points of view) ideological disciplinary divisions in social science, by developing a common basis in a resurgent historical materialism.See also NEO-CLASSICAL ECONOMICS.

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economics

ec·o·nom·ics
/ ˌekəˈnämiks; ˌēkə-/
•
pl. n. [often treated as sing.]
the branch of knowledge concerned with the production, consumption, and transfer of wealth. ∎
the condition of a region or group as regards material prosperity:
he is responsible for the island's modest economics.

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